From the start of 1995, US equity prices exploded upwards, with the
S&P500 index rising 62 per cent by the end of 1996. By the end of 1994,
the stock market had already experienced a remarkable twelve year ascent,
during which equities had surged by 200 per cent, despite the plunge
of 1987 and the mini-crash of 1989. But that spectacular climb in asset
values had been more or less justified, and indeed driven, by a corresponding
rise in corporate profits, the same revival of the rate of return that
had brought the US economy by this juncture to the brink of a new take
off. There can be no doubt that the long bull run of the stock market
predisposed investors to continue to buy shares. But what actually drove
equities to take flight was, almost certainly, a sudden sharp fall in
the cost of borrowing, both short and long term. To help insure stability
in the wake of the Mexican Peso and Southern American Tequila crises,
the Fed abruptly discontinued its campaign to raise short term interest
rates of the previous year and reduced the cost of short term borrowing,
from 6.05 per cent in April 1995 to 5.2 per cent in January 1996, not
to increase it again until 1999 (except for a lone quarter point increase
in 1999). Meanwhile, to implement the Reverse Plaza Accord and bring
down the yen, Japan cut its discount rate and, along with other governments
in East Asia aiming to keep down their own currencies, unleashed a huge
wave of purchases of dollar denominated assets, especially treasury
bonds. The reduction in the cost of borrowing in Japan had the effect
of pumping up the global supply of credit, as international financiers
fabricated a very profitable carry trade, borrowing yen at low rates
of interest, converting them into dollars, and using the proceeds to
invest around the world, not least in the US stock market. The buying
up of US government debt by the East Asians appears to have been the
main factor in bringing about a stunning twenty-three per cent decline
in the long term cost of borrowing over the course of 1995. As is usually
the case with asset price run-ups, it was the sudden major easing of
credit that catalyzed the new rise of the stock market. But, by now,
with the dollar ascending, the material foundations of the long term
profitability recovery and associated rise in equity prices were crumbling.
The stock market was climbing skyward without a ladder.

This is where Alan Greenspan and the Fed enter the picture.

At the 24 September 1996 meeting of the Federal Open Market Committee,
the body that sets short term interest rates for the US economy, Federal
Reserve Governor Lawrence Lindsey expressed his worry that runaway increases
in share prices were far exceeding the potential growth of corporate
profits, and that a distorting bubble, which could not but make for
a vast misallocation of capital and eventually a destructive bust, was
in the offing. Fed Chair Greenspan did not for a moment deny Lindsay’s
observation. “I recognize that there is a stock market bubble problem
at this point, and I agree with Governor Lindsey that this is a problem
that we should keep an eye on.” Greenspan acknowledged, moreover, that
the Fed had ample means at its disposal to deflate the bubble, if it
so chose. “We do have the possibility of raising major concerns by increasing
margin requirements. I guarantee that if you want to get rid of the
bubble, whatever it is, that will do it. My concern is that I am not
sure what else it will do.”7
In fact, as 7 FOMC Minutes, 24 September 1996,
pp.23-25, 30-31 Fed Reserve web site; William A. Fleckenstein,
Greenspan’s
Bubbles. The Age of Ignorance at the Federal Reserve, New York, 2008, p.135.
Greenspan made crystal clear at this meeting and subsequently,
he had no interest in combating the bubble by any method whatsoever.
The economy did seem to be gathering steam, but he was not sure that
the expansion had fully taken hold, and he was reluctant to consider
raising interest rates, let alone risk directly undermining the equity
markets by raising margin requirements, unless and until he was certain
it had.8

At the next FOMC meeting, on 13 November 1996, Governor Lindsey,
supported by several others, re-stated his concern about over-valued
share prices, as well as the threat of inflation, and recommended a
significant interest rate increase. But Greenspan preferred standing
pat and, as always, he won the day.9
A few weeks later, on December 1996, Greenspan did give his famous
warning about “irrational exuberance” in the equity markets. Yet not
only did share values continue to rocket into the heavens, but the Fed
did absolutely nothing about it. Greenspan not only failed to raise
interest rates in the normal way as the economic expansion extended
itself, increasing the Federal Funds rate on just one solitary occasion
in the years 1995-1999, and that by just onequarter of a percentage
point. He also brought down the cost of borrowing at every point at
which the stock market experienced the slightest tremor of fear, a fact
not lost on equity investors, who soon came to take for granted the
infamous “Greenspan put.”

Still, there was a method to Greenspan’s
madness. The Fed chair well understood the downward pressure on the
economy that was resulting from the rise of the dollar, the disappearance
of the Federal deficit, and the declining capacity of the rest of the
world to power its own expansion, let alone pull the US economy forward.
With traditional Keynesianism off the agenda, he had to find an alternative
way to insure that the growth of demand would be sustained. Although
Greenspan did not explicitly refer to this, he was well aware that,
during the previous decade, the Japanese had implemented a novel form
of economic stimulus. In 1985-1986, following the Plaza Accord, Japan
had faced a situation rather similar to that of the US in 1995-1996.
A fast rising yen had put a sudden end to Japan’s manufacturing-centered,
export-led expansion of the previous half decade, was placing harsh
downward pressure on prices and profits, and was driving the economy
into recession. To counter the incipient cyclical downturn, the Bank
of Japan radically reduced interest rates, and saw to it that banks
and brokerages channeled the resulting flood of easy credit to stock
and land markets. The historic run-ups of equity and land prices that
ensued during the second half of the decade provided the increase in
paper wealth that was required to enable both corporations and households
to step up their borrowing, raise investment and consumption, and keep
the economy expanding. The great Japanese
boom—and accompanying bubbles--of the second half of the 1980s was the
outcome.

Greenspan followed the Japanese example.
By nursing instead of limiting the ascent of equity prices, he created
the conditions under which firms and households could borrow easily,
invest in the stock market, and push up share values. As companies’ stock market valuations rose, their net worth increased
and they were enabled to raise money with consummate ease--either by
borrowing against the increased collateral represented by their enhanced
capital market valuations or by selling their overvalued equities--and,
on that basis, to step up investment. As wealthy households’ net worth
inflated, they could reduce saving, borrow more, and increase consumption.
Instead of supporting growth by increasing its own borrowing and deficit
spending--as with traditional Keynesianism--the government would thus
stimulate expansion by enabling corporations and rich households to
increase their borrowing and deficit spending by making them wealthier (at least
on paper) by encouraging speculation in equities—what might be called
“asset price Keynesianism”.

The “wealth effect” of rising asset prices would, in this way, underwrite
a boom for which the underlying fundamentals were lacking --
notably, the prospect of sufficient rate
of return on investment. Greenspan’s stimulus program
was a dream come true for corporations and the wealthy, as well as for
banks and other financiers, who could hardly fail to profit on lending,
by way of the Fed’s unspoken commitment to moderate short term interest
rates and to reduce them whenever this was necessary to prevent equity
prices from plunging. Its implementation is incomprehensible apart from
an accelerating shift to the right in the polity as a whole and ushered
in what has been rightly termed the New Gilded Age. Nevertheless,
it invited not only the blowing up, but also the bursting, of momentous
asset price bubbles.

Much as in Japan, the Fed’s buttressing of the stock market called forth
a share price ascent of historic proportions, and one witnessed still
another re-enactment of the classic drama of asset price run-ups familiar
throughout history. The basic enabling condition
was, as usual, low-cost access to credit, both long term—initially
bequeathed by the Japanese and East Asians by way of their massive purchases
of US treasury bonds in connection with the reverse Plaza Accord --
and short term — provided, and seemingly assured, by the Fed. With credit
made so cheap, and profit-making on lending rendered so easy,
banks and non-bank financial institutions
could not resist opening the floodgates and advancing funds without
limit. Stepped up borrowing made possible jumped up investment
in stocks, which drove up share values, thus households’ wealth and
firms’ market capitalization. The resulting decrease in the ratio of
debt to equity for stock market investors, as well as for corporations,
made those investors and corporations more credit worthy, at least in
appearance. Financiers could therefore justify to themselves, as they
have always tended to do in such situations, further increases in lending
for further purchases of financial assets, as well as for plant and
equipment, paving the way for more speculation, higher asset prices,
and of course still more lending -- a self-perpetuating upward spiral.

That said, however, I nevertheless wish that it would have delved
a little more into the underlying dogmas and pseudoscience that underpin
the philosophies of Rand, Greenspan, Rubin, Summers, Bernanke and Geithner.

“A consistent pessimism in regard to man’s rational capacity for
justice invariably leads to absolutistic political theories,” Reinhold
Niebuhr cautions us in “The children of light and the children of darkness”;
“for they prompt the conviction that only preponderant power can coerce
the various vitalities of a community into working harmony.”

And there can be little doubt as to how Niebuhr would have judged
Rand, Greenspan, Rubin, Summers, Bernanke and Geithner: “the moral cynics,
who know no law beyond their will and interest, with a scriptural designation
of ‘children of this world’ or ‘children of darkness’. “

“This is no mere arbitrary device,” Niebuhr goes on to explain; “for
evil is always the assertion of some self-interest without regard to
the whole, whether the whole be conceived as the immediate community,
or the total community of mankind, or the total order of the world.”

Martin Luther King was to pick up on and greatly elaborate upon the
“children of darkness,” their pessimism concerning man’s moral and rational
resources to achieve fairness and justice:

Plato, centuries ago said that the human personality is like a
charioteer with two headstrong horses, each wanting to go in different
directions, so that within our own individual lives we see this conflict
and certainly when we come to the collective life of man, we see a strange
badness. But in spite of this there is something in human nature that
can respond to goodness. So that man is neither innately good nor is
he innately bad; he has potentialities for both. So in this sense, Carlyle
was right when he said that, “there are depths in man which go down
to the lowest hell, and heights which reach the highest heaven, for
are not both heaven and hell made out of him, ever-lasting miracle and
mystery that he is?” Man has the capacity to be good, man has the capacity
to be evil.

And so the nonviolent resister never lets this idea go, that there
is something within human nature that can respond to goodness. So that
a Jesus of Nazareth or a Mohandas Gandhi, can appeal to human beings
and appeal to that element of goodness within them, and a Hitler can
appeal to the element of evil within him.
–Martin Luther King, “Love, law and civil disobedience”

What we saw beginning about sixty years ago was the rollout of a
full court press by the children of darkness. It pervaded every aspect
of our thinking lives—art, science, religion, economics and politics.
And the New Atheist Ayn Rand was undoubtedly the high priestess of the
paladins of selfishness and greed.

But she has many disciples, including the Four Horsemen—the new New
Atheists Richard Dawkins, Dan Dennett, Christopher Hitchens and Sam
Harris. Probably nowhere are the pseudoscientific half-truths they peddle
more amply revealed than in this lecture by Richard Dawkins (beginning
at minute 40:00):

For a long time, certainly during all of Rand’s lifetime, the New
Atheists, without a doubt due to their deep-pocked patrons and sponsors,
ran roughshod over the academic community. Anyone foolish enough to
assert “man’s capacity to do good” was exiled into academic oblivion.
However, with more recent findings by neuroscientists, the “red in tooth
and claw” portrayal of man proselytized by the New Scientists has become
empirically indefensible.

So what can be seen in Dawkins’ presentation is his acknowledgment
that man does indeed have the capacity to do good, but with the qualification
that this is a “mistake” or “misfire.” Man ought to follow his
instincts for greed and selfishness, Dawkins advises us, because these
benevolent impulses no longer function to enhance survival.

On the religious front, the perversion and corruption is just as
egregious. We find the mirror image of Dawkins, Dennett, Harris and
Hitchens in such well-known Christian evangelical figures as Pat Robertson,
Jerry Falwell, James Dobson, Jim Bakker, Tim LaHaye, James Robinson
and a host of other millionaire preachers. Other denominations notable
for smiling kindly upon greed and selfishness are the Mormons and the
Missouri Synod Lutherans. Kevin Phillips, Andrew J. Bacevich and Greg
Grandin, between the three of them do a superb job of researching the
current state of right-wing religion in America and its celebration
of greed and selfishness.

In the arts, we see the “greed is good” message not only overtly
verbalized by the artist, but also conveyed in the iconic sharks and
gold-plated bulls of the billionaire-artist Damien Hirst.

And I suppose this audience needs no schooling on how, as Amitai
Etzioni so thoroughly documented in The Moral Dimension, “neoclassicists
have labored long and hard to show that practically all behavior is
driven by pleasure and self-interest.” “The neoclassical paradigm does
not merely ignore the moral dimension but actively opposes its inclusion,”
he writes.

And politics? What can we say about politics?

Francois Haas in “German science and black racism—roots of the Nazi
Holocaust” posits a rather interesting theory. Traditional political
theory, Haas explains, holds that “science under dictatorship becomes
subordinated to the guiding philosophy of the dictatorship.” Haas, however,
says: “I am proposing the inverse, that Politics under Science becomes
subordinated to the guiding philosophy of that Science.”
http://www.fasebj.org/cgi/content/abstract/22/2/332

So as the little piece of ground that the New Atheists stand upon
is eroded away, as the tyranny they inflicted upon the academe is swept
away, does that not give hope that the evil politics they inspired will
also be swept away?

The new FRONTLINE documentary
The Warning, scheduled to debut next Tuesday, is not likely to provide
any assistance in the "reputation rebuilding" effort by former Fed Chairman
Alan Greenspan whose comments yesterday regarding "too
big to fail" might be seen in a whole new light given new revelations
from the late-1990s about regulation of
derivatives.

Pictured above with former Treasury Secretary and Goldman Sachs alum
Robert Rubin, this duo constituted two-thirds of the "Committee to Save
the World" (along with top Obama administration economic adviser Larry
Summers), a call that, in retrospect, may have been a bit premature.

Brooksley Born:

"We didn't truly know the dangers of the market, because it was
a dark market," says Brooksley Born, the head of an obscure federal
regulatory agency -- the Commodity
Futures Trading Commission (CFTC) --
who not only warned of the potential for economic meltdown in the
late 1990s, but also tried to convince the country's key economic
powerbrokers to take actions that could have helped avert the crisis.
"They were totally opposed to it," Born says. "That puzzled
me. What was it that was in this market that had to be hidden?"

In The Warning, airing Tuesday, Oct. 20, 2009, at 9 P.M. ET on PBS
(check local listings), veteran FRONTLINE producer Michael Kirk
(Inside
the Meltdown,
Breaking the Bank) unearths the hidden history of the nation's
worst financial crisis since the Great Depression.
At the center of it all he finds Brooksley Born, who speaks for
the first time on television about her failed campaign to regulate
the secretive, multitrillion-dollar derivatives market whose
crash helped trigger the financial collapse in the fall of 2008.

"I didn't know Brooksley Born," says former SEC Chairman Arthur
Levitt, a member of President Clinton's powerful Working Group on
Financial Markets. "I was told that she was irascible, difficult,
stubborn, unreasonable." Levitt explains how the other principals
of the Working Group -- former Fed Chairman
Alan
Greenspan
and former Treasury Secretary Robert Rubin -- convinced him that
Born's attempt to regulate the risky derivatives market could lead
to financial turmoil, a conclusion he now believes was "clearly
a mistake."

Born's battle behind closed doors was epic, Kirk finds. The members
of the President's Working Group vehemently opposed regulation --
especially when proposed by a Washington outsider like Born.

"I walk into Brooksley's office one day; the blood has drained from
her face," says Michael Greenberger, a former top official at the
CFTC who worked closely with Born. "She's hanging up the telephone;
she says to me:
'That was [former Assistant Treasury Secretary] Larry Summers. He
says, "You're going to cause the worst financial crisis since the
end of World War II."... [He says he has] 13 bankers in his office
who informed him of this. Stop, right away. No more.'"

Greenspan, Rubin and Summers ultimately prevailed on Congress to
stop Born and limit future regulation of derivatives. "Born faced
a formidable struggle pushing for regulation at a time when the
stock market was booming," Kirk says. "Alan Greenspan was the maestro,
and both parties in Washington were united in a belief that the
markets would take care of themselves."

Now, with many of the same men who shut down Born in key positions
in the Obama administration, The Warning reveals the complicated
politics that led to this crisis and what it may say about current
attempts to prevent the next one.

"It'll happen again if we don't take the appropriate steps,"
Born warns. "There will be significant financial downturns and disasters
attributed to this regulatory gap over and over until we learn from
experience."

This should be good, particularly in light of the fact that there has
been virtually no progress on any financial market reforms, despite
continuing calls from the likes of Paul Volcker.

A book titled Affluenza (by John De Graaf, David Wann, and
Thomas H. Naylor) sums it up: “The dogged pursuit for more” accounts
for Americans’ “overload, debt, anxiety, and waste.” If Americans are
out of money, it must be because they are over-consuming—buying junk
they don’t really need.

We know why the bubble occurred. Call its Greenspanism. Central banks
rescued assets each time there was a hiccup, but let booms run unchecked.
They pulled "real" rates ever lower, creating addiction to monetary
stimulus. Larger doses were required with each cycle, until we hit zero,
and it is still not enough. Debt burdens rose to records across the
OECD.

After retiring as the Federal Reserve’s second longest ever serving
chairman, Alan Greenspan is now cashing in big late in life at age 81.
He chaired the Fed’s Board of Governors from the time he was appointed
in August, 1987 to when he stepped down January 31, 2006 amidst a hail
of ill-deserved praise for his stewardship during good and perilous
times. USA Today noted “the onetime jazz band musician went out on a
high note.” The Wall Street Journal said “his economic legacy (rests
on results) and seems secure.” The Washington Post cited his “nearly
mythical status.”

Stanford Washington Research Group chief strategist Greg Valliere
called him a “giant,” and Bob Woodward called him “Maestro” in his cloying
hagiography (now priced $1.99 used on Alibris and $2.19 on Amazon) that
was published in 2000 as the Greenspan-built house of cards was collapsing.
The book was an adoring tribute to a man he called a symbol of American
economic preeminence, who the Financial Times also praised as “An Activist
Unafraid to Depart From the Rule” - by taking from the public and giving
to the rich.

Others joined the chorus, too, lauding his steady, disciplined hand
on the monetary steering wheel, his success keeping inflation and unemployment
low, and his having represented the embodiment of prosperity in compiling
a record of achievement his successor will be hard-pressed to match.

In 2004, William Greider in The Nation magazine had a different view.
He’s the author of “Secrets of the Temple” on “how the Federal Reserve
runs the country.” He wrote Greenspan “ranks among the most duplicitous
figures to serve in modern American government (who used) his exalted
status as economic wizard (to) regularly corrupt the political dialogue
by sowing outrageously false impressions among gullible members of Congress
and adoring financial reporters.”

They were front and center in the New York Times for the man who
“steer(ed) the economy through multiple calamities and ultimately….one
of the longest economic booms in history….(He earned his bona fides)
weather(ing) the Black Monday stock crash of 1987 (and in 18 and a half
years in office) achieved more celebrity than most rock stars” and may
now approach them in earnings.

The new book of his memoirs “The Age of Turbulence” is just out for
which his reported advance exceeded $8.5 million (second only to Bill
Clinton’s $10 for his memoirs) plus additional royalties if sales exceed
1.9 million copies. They may given the amount of high-impact publicity
it and he are getting nonstop. And that’s not all. He’s in great demand
on the lecture circuit at six figure fees, has his own consulting firm,
Greenspan Associates LLC, and his lawyer, Robert Barnett says “virtually
every major investment-banking firm” in the world wants to hire him
for his rainmaking connections.

They have value, not his market advice, best avoided for the man
who engineered the largest ever stock market bubble and bust in history
through incompetence, timidity, dereliction of duty, and subservience
to the capital interests he represented at the expense of the greater
good and a sustained sound economy he didn’t worry about nor did Wall
Street.

For firms on the Street and big banks, he could do no wrong and was
above reproach for letting them cash in big and then get plenty of advance
warning when to exit. Most ordinary investors weren’t so fortunate.
They’re not insiders and were caught flat-footed by advice from market
pundit fraudsters and the most influential one of all in the Fed Chairman.
Just weeks before the market peak in January, 2000, he claimed “the
American economy was experiencing a once-in-a-century acceleration of
innovation, which propelled forward productivity, output, corporate
profits and stock prices at a pace not seen in generations, if ever.”

It was hype and nonsense and on a par with famed economist and professor
Irving Fisher’s remarks just before the 1929 stock market crash and
Great Depression when he claimed economic fundamentals in the country
were strong, stocks undervalued, and an unending period of prosperity
lay ahead. It took a world war a decade later, not market magic, for
them to arrive, but before it did Fisher kept insisting in the early
1930s recovery was just around the corner. It’s the same way Wall Street
touts operate today on gullible investors who even after they’ve been
had are easy prey again for the next con.

And they’re really in trouble when it comes from the “Maestro,” who
at the height of the stock market bubble said: “Lofty equity prices
have reduced the cost of capital. The result has been a veritable explosion
of spending on high-tech equipment…And I see nothing to suggest that
these opportunities will peter out anytime soon….Indeed many argue that
the pace of innovation will continue to quicken….to exploit the still
largely untapped potential for e-commerce, especially the business-to-business
arena.”

One week later, the Nasdaq peaked at 5048 and crashed to a low of
1114 on October 9, 2002. It lost 78% of its value, the S&P 500 stock
index dropped 49%, and retail investors lost out while Greenspan was
busy engineering another bubble with a tsunami of easy money for Wall
Street and big investors. It’s now unwinding as he gets a big payday
for his memoirs and a chance to rewrite history. He aims to raise himself
to sainthood and at the same time distance himself from the very costly
policies he implemented on top of trillions he helped scam in the greatest
modern era wealth transfer from the public to the rich. More on that
below.

Greenspan’s Background and Tenure as Federal Reserve Chairman

Alan Greenspan grew up in New York, got his B.A. and M.A. in economics
from New York University and later was awarded a Ph.D. in economics
from Columbia without completing a dissertation the degree usually requires.
In a highly unusual move, Columbia made an exception in his case.

Early on, he became enamored with free market ideologue Ayn Rand,
wrote for her newsletters and authored three essays for her book “Capitalism:
The Unknown Ideal.” It expressed her views on capitalism’s “moral aspects”
and her attempt (with Greenspan’s help) to rescue it from its “alleged
champions who are responsible for the fact that capitalism is being
destroyed without a hearing (or) trial, without any public knowledge
of its principles, its nature, its history, or its moral meaning.”

That was in 1966 when Rand, a staunch libertarian as is Greenspan,
believed fundamentalist capitalism was being battered by a flood of
altruism in the wake of New Deal and Great Society programs she (and
Greenspan) abhorred. She defended big business, made excuses for its
wars, and denounced the student rebellion at the time and the evils
of altruism. Greenspan concurred, maintained a 20 year association with
Rand (who died in 1982), and never looked back.

From 1948 until his 1987 Federal Reserve appointment, he served as
Richard Nixon’s domestic policy coordinator in his 1968 nomination campaign
and later as Gerald Ford’s Council of Economic Advisers Chairman. He
also headed the economic consulting firm, Townsend-Greenspan & Company,
from 1955 - 1987. Its forecasting record was so poor it was about to
be liquidated when he left to join the Fed. A former competitor, Pierre
Renfret, noted: “When Greenspan closed down his economic consulting
business to (become Fed Chairman) he did so because he had no clients
left and the business was going under (and we found) out he had none
(of his employees left).” That made him Reagan’s perfect Fed Chairman
choice, and Renfret added it was Greenspan’s failure in private business
that got him into government service in the first place.

He wouldn’t disappoint as Wall Street’s man from the start. He bailed
it out in 1987 after the disastrous October black Monday. It was the
same way he did in it later in 1998 following Long Term Capital Management’s
collapse and again after the dot-com bubble burst. It was by his favorite
monetary medicine guaranteed to work when taken as directed - floods
of easy money followed by still more until the patient is healed, unmindful
that the cure may be worse than the disease. No matter, it’s a new Chairman’s
problem with Greenspan claiming no culpability for his 18 and a half
year tenure of misdeeds, subservience to capital, and contempt for the
public interest.

His new book claims the opposite. It’s a breathtaking example of
historical revisionism that’s become standard practice for the man Sydney
Morning News’ Political and International Editor Peter Hartcher calls
“Bubble Man” in his new book by that title. In it, he quotes Bob Woodward
saying Greenspan “believed he had done all he could” to contain over-exuberance
when, in fact, he let it get out of control. He now claims:

– he didn’t support George Bush’s regressive tax cuts for the rich
(that helped create huge budget deficits). In fact, he did, and in 2001
wholeheartedly endorsed this centerpiece of the administration’s economic
policy in his testimony before the Senate Budget Committee. At the time,
he cited the economic slowdown saying: “Should current economic weakness
spread….having a tax cut….may….do noticeable good.”

– he’s “saddened (in his book) that it is politically inconvenient
to acknowledge what everyone knows: the Iraq war is largely about oil.”
In his typical obfuscating way to confuse and have things both ways,
he tried clarifying his position in a September interview claiming:
“I was not saying that that’s the administration’s motive. I’m just
saying that if somebody asked me, are we fortunate in taking out Saddam?
I would say it was essential.” He failed to say he supported the Bush
administration agenda across the board, including the Afghanistan and
Iraq wars, with reasons given at the time he’s now distancing himself
from.

– no responsibility for the 2000 stock market bubble. He falsely
claimed he never saw it coming while providing generous amounts of liquidity
to fuel it. After citing the market’s “irrational exuberance” in a December,
1996 speech, he failed to curb it and could have by raising interest
rates, margin requirements, and jawboning investors to cool an overheated
market to restore stability for long-term economic growth. Instead,
he did nothing. He failed to take away the punch bowl, created a bubble,
and allowed it to burst causing investors (mostly retail ones) to lose
trillions.

– no responsibility for the housing and bond bubbles he created by
cutting interest rates aggressively to 1% and flooding the markets with
liquidity. As things got out of hand, timely responsible action could
have avoided the summer, 2007 credit crisis. Again, he allowed a bad
situation to get worse to keep the party going and allow lenders to
profit hugely. In the unprecedented run-up in house prices to an $8
trillion wealth bubble, he derided critics claiming anything was wrong.
He even encouraged homebuyers to take out adjustable rate mortgages,
approved of very risky no down payment purchases, created the subprime
mess as a consequence, and isn’t around to address buyers faced with
$1.2 trillion in mortgage resets later this year and next that will
cause many thousands of painful foreclosures.

Affected homeowners won’t likely be cheered by his speech-making
bunkum that bubble level asset prices proved his monetary policies worked
by getting investors to demand lower risk premiums. They also won’t
be calmed by his arrogant claim that it’s “simply not realistic” to
expect the Fed to identify and deflate asset bubbles when it’s real
role is to champion flexible and unregulated markets leaving everyone
unprotected on our own.

– no responsibility for allowing outstanding US debt to more than
triple to around $40 trillion on his watch that one analyst calls his
“most conspicuous achievement.” Those having to pay it off won’t thank
him.

Greenspan’s Role in the Greatest Modern Era Wealth Transfer
from the Public to the Rich

Greenspan was a one-man wrecking crew years before he became Fed
Chairman, and his earlier role likely sealed the job for him as a man
the power elite could trust. He earned his stripes and then some for
his role in charge of the National Commission on Social Security Reform
(called the Greenspan Commission). He was appointed by Ronald Reagan
to chair it in 1981 to study and recommend actions to deal with “the
short-term financing crisis that Social Security faced….(with claims
the) Old-Age and Survivors Insurance Trust Fund would run out of money….as
early as August, 1983.”

There was just one problem. It was a hoax, but who’d know as the
dominant media stayed silent. They let the Commission do its work that
would end up transfering trillions of public dollars to the rich. It
represents one of the greatest ever heists in plain sight, still ongoing
and greater than ever, with no one crying foul to stop it. The Commission
issued its report in January, 1983, and Congress used it as the basis
for the 1983 Social Security Amendments to “resolve short-term financing
problem(s) and (make) many other significant changes in Social Security
law” with the public none the wiser it was a scam harming them.

The Commission recommended:

– Social Security remain government funded and not become a voluntary
program (that would have killed it);

– $150 - 200 billion in either additional income or decreased outgo
be provided the Old Age, Survivors, and Disability Insurance (OASDI)
Trust Funds in calendar years 1983 - 89;

– the actuarial imbalance for the 75 year Trust Funds valuation period
of an average 1.80% of taxable payroll be resolved;

– a “consensus package” to fix the problem by raising payroll taxes
on incomes but exempting the rich beyond a maximum level taxed. Also
a gradual increase in the retirement age and various other possible
short and longer range options for consideration. The result today is
low income earners pay more in payroll than income tax. For bottom level
earners, the burden is especially onerous. They pay no income tax but
aren’t exempt from 6.2% of their wages going for Social Security and
Medicare.

– coverage under OASDI be extended on a mandatory, basis as of January
1, 1984, to all newly hired civilian employees of the federal government
and all employees of nonprofit organizations;

– state and local governments that elected coverage for their employees
under the OASDI-HI program not be allowed to terminate it in the future;

– the method of computing benefits be revised to exclude benefits
that can accrue to individuals from non-covered OASDI employment and
only be for the period when they became eligible - to eliminate “windfall”
benefits;

– 50% of OASDI benefits should henceforth be taxable as ordinary
income for individuals earning $20,000 or more and married couples $25,000
or more;

– in addition, other recommendations concerning cost of living adjustments,
the law pertaining to surviving spouses who remarry after age 60, divorced
spouses, disabled widows and widowers, and for scheduled payroll tax
increases to move up to earlier years up to 1990 after which no further
change be made with the wage base rising and is now at a level of $97,500
in 2007 at a tax rate of 6.2% matched by employers;

– self-employed persons beginning in 1984 pay the combined employer-employee
rates now at 12.4% with half considered a business expense;

– in addition, a number of other changes recommended that in total
would penalize the public to benefit the most well-off that was the
whole idea of the scheme in the first place.

The public was told the Commission recommendations of 1983 were supposed
to make Social Security fiscally sound for the next 75 years. They weren’t
told there was no problem to fix and the changes enacted were to transfer
massive wealth from the public to the rich. It was one part of an overall
Reagan administration scheme that included huge individual and corporate
tax cuts that took place from 1981 to 1986. The rich benefitted most
with top rates dropping from 70% in 1981 to 50% over three years and
then to 28% in 1986 while the bottom rate actually rose from 11 to 15%.

It was the first time US income tax rates were ever reduced at the
top and raised at the bottom simultaneously. But it was far worse than
that. In only a few years, Reagan got enacted the largest ever US income
tax cut (mostly for the rich) while instituting the greatest ever increase
entirely against working Americans earning $30,000 or less.

Alan Greenspan engineered it for him by supporting income tax cuts
and doubling the payroll tax to defray the revenue shortfall. He also
recommended raiding the Social Security Trust Fund to offset the deficit,
and who’d know the difference. His scheme helped make the US tax code
hugely regressive as well as for the first time transform a pay-as-you-go
retirement and disability benefits program into one where wage earner
contributions subsidize the rich as well as support current beneficiaries.

As a consequence, the wealth gap widened, continued under Clinton
but became unprecedented under George W. Bush with Greenspan at it again.
He supported the administration’s wealth transfer scheme to the rich
and outsized corporate subsidies with the public getting stuck with
out-of-control deficits, deep social service cuts, and a new Treasury
Department report just out promising more of the same.

It claims Social Security faces a $13.6 trillion shortfall “over
the indefinite future,” “reforms” are needed, delaying them punishes
younger workers, and the program “can be made permanently solvent only
by reducing the present value of scheduled benefits and/or increasing
the present value of scheduled tax increases.” Translation: cut benefits
deeply, raise payroll taxes, and privatize Social Security so more public
wealth goes to Wall Street and big investors.

Already the top 1% owns 40% of global assets; the top 10% 85% of
them; the top 1% in the US controls one-third of the nation’s wealth;
the bottom 80% just 15.3%; and the top 20% 84.7%. In contrast, the poorest
20% are in debt, owe more than they own, and it’s getting worse.

A generation of financial manipulation devastated working Americans,
but it’s even worse than that. Added are the effects of globalization,
automation, outsourcing, the shift from manufacturing to services, deregulation,
other harmful economic factors plus weak unions just gotten far weaker
in the wake of the UAW September membership sellout to General Motors.
The tentative agreement reached (for members to vote on) amounted to
an unconditional surrender by a corrupted leadership after a two day
walkout that was likely orchestrated in advance to cause GM the least
pain. If the package is approved as is likely, it will encourage other
companies to offer similar deals, take it or leave it. Organized labor
suffered another grievous blow, corporate giants gained, and are more
empowered than ever to win out at the expense of workers’ futures.

The whole scheme was kick-started under Ronald Reagan. Between his
tax cuts for the rich and the Greenspan Commission’s orchestrated Social
Security heist, working Americans lost out in a generational wealth
transfer shift now exceeding $1 trillion annually from 90 million working
class households to for-profit corporations and the richest 1% of the
population. It created an unprecedented wealth disparity that continues
to grow, shames the nation and is destroying the bedrock middle class
without which democracy can’t survive.

Greenspan helped orchestrate it with economist Ravi Batra calling
his economics “Greenomics” in his 2005 book “Greenspan’s Fraud.” It
“turns out to be Greedomics” advocating anti-trust laws, regulations
and social services be ended so “nothing….interfere(s) with business
greed and the pursuit of profits.”

It won’t affect the “Maestro.” He’s getting by quite nicely on his
six figure retirement income that’s just a drop in the bucket supplementing
the millions he’s making as payback for the trillions he helped shift
to the rich and super-rich. They take care of their own, and Greenspan
is one of them.

Jules on October 5th, 2007

This article is very interesting I always felt he (Greenspan) was
a snake, it is obvious - just look at him, but I did not know that he
is one of the economic masterminds behind the “rich get richer, poor
get poorer” machine. Whats horrible is that they will all get away with
it - Americans have been brainwashed so completely. They just can’t
seem to wrap their self-centered, cowardly minds around this International
Banking Fraud and Secret Govt. Even worse is the fact that they (Americans)
are the only ones who can fix this; all they have to do is REFUSE to
believe their lies and REFUSE their system of money, credit, etc. Then
replace it with one they want.
Obstacles: 1)Ignorance 2) Laziness 3)Cowardice Martin on October
6th, 2007

Jules, you are right, but please understand that what our laziness
and cowardliness create is the very ignorance you speak of. Our largest
problem is that this article, and the books mentioned will not be ready
by the American public, they (we) are too busy watching Britney Spears
and the like on TV.

I believe the only way for Americans to change or wake up is to force
their TV’s off. TV and the laziness and brainwashing that it encourages
is so addictive that Americans can’t be bothered to read or discuss
items other than celebrities, we simply want to be told, and entertained;
even if it means being lied to and hoodwinked and sold to the lowest
bidder.

Anyhow, I can’t blame Greenspan for too much, because honestly, he
represents the Federal Reserve, and that (I believe history will show)
is the very institution responsible for America’s demise. Just check
out this quote from Frank Vanderlip’s biography …

“I was as secretive, indeed I was as furtive as any conspirator.
Discovery, we knew, simply must not happen, or else all our time and
effort would have been wasted. If it were to be exposed that our particular
group had got together and written a banking bill, that bill would have
no chance whatever of passage by Congress…I do not feel it is any exaggeration
to speak of our secret expedition to Jekyll Island as the occasion of
the actual conception of what eventually became the Federal Reserve
System.” —

The “Group” he speaks of is not the US Government and not one that
is interested in the betterment of general Americans but none other
than …

“The executives included Frank Vanderlip, president of the National
City Bank of New York, associated with the Rockefellers; Henry Davison,
senior partner of J. P Morgan Company; Charles D. Norton, president
of the First National Bank of New York; and Col. Edward House, who would
later become President Woodrow Wilson’s closest adviser and founder
of the Council on Foreign Relations.[3] There, Paul Warburg of Kuhn,
Loeb, & Co. directed the proceedings and wrote the primary features
of the Federal Reserve Act. Warburg would later write that “The matter
of a uniform discount rate (interest rate) was discussed and settled
at Jekyll Island.” … who wrote the bill to introduce the Federal Reserve
for THEIR INTERESTS, not yours and mine, BUT THEIRS.

There is a reason the above article (the main article on this page)
speaks of the great divide between classes now is directly related to
the people who guaranteed that outcome for their families in 1913. This
meeting was kept secret by this group for 3 years AFTER they had passed
the bill via their purchased congressmen.

America was screwed and purchased on the cheap in 1913, we still
have yet to recover from this slight of hand. Alan Greenspan …. he is
just another pawn in the long list of Federal Reserve pawns hired to
do the bidding of their masters … The great depression was orchestrated
by this group and our greatest depression (soon to be seen) has been
orchestrated by their ancestors and followers … Ask yourself who benefits
from it, and then ask yourself when, if ever, you will see a story about
it on the major news networks. Don’t ever forget that John F Kennedy
was assassinated because he threatened to shut down the Federal Reserve.
I believe they simply could not let that happen after 30 years of absolute
financial control.

Greenspan was no mastermind, he did what they told him to do, and
he did his job well. We must expose “them”.

– Federal Reserve Creative Group Information found on Wikipedia but
confirmed in countless other sources.

If this not criminal negligence, what is ?

But during the years of the housing boom, the pleas failed to move
the Fed, the sole federal regulator with authority over the businesses.
Under a policy quietly formalized in 1998, the Fed refused to police
lenders' compliance with federal laws protecting borrowers, despite
repeated urging by consumer advocates across the country and even by
other government agencies.

The hands-off policy, which the Fed reversed earlier this month,
created a double standard. Banks and their subprime affiliates made
loans under the same laws, but only the banks faced regular federal
scrutiny. Under the policy, the Fed did not even investigate consumer
complaints against the affiliates.

"In the prime market, where we need supervision less, we have lots
of it. In the subprime market, where we badly need supervision, a majority
of loans are made with very little supervision," former Fed Governor
Edward M. Gramlich, a critic of the hands-off policy, wrote in 2007.
"It is like a city with a murder law, but no cops on the beat."

Between 2004 and 2007, bank affiliates made more than 1.1 million
subprime loans, around 13 percent of the national total, federal data
show. Thousands ended in foreclosure, helping to spark the crisis and
leaving borrowers and investors to deal with the consequences.

Congress now is weighing whether the Fed should be fired. The Obama
administration has proposed shifting consumer protection duties away
from the Fed and other banking regulators and into a new watchdog agency.
That proposal, a central plank in the administration's plan to overhaul
financial regulation, is opposed by the industry and faces a battle
on Capitol Hill.

The Federal Reserve is best known as an economic shepherd, responsible
for adjusting interest rates to keep prices steady and unemployment
low. But since its creation, the Fed has held a second job as a banking
regulator, one of four federal agencies responsible for keeping banks
healthy and protecting their customers. Congress also authorized the
Fed to write consumer protection rules enforced by all the agencies.

During the boom, however, the Fed left those powers largely unused.
It imposed few new constraints on mortgage lending and pulled back from
enforcing rules that did exist.

The Fed's performance was undercut by several factors, according
to documents and more than two dozen interviews with current and former
Fed governors and employees, government officials, industry executives
and consumer advocates. It was crippled by the doubts of senior officials
about the value of regulation, by a tendency to discount anecdotal evidence
of problems and by its affinity for the financial industry.

How well has the Federal Reserve performed for America? Mainstream
pundits, of course, say that Bernanke has saved the world . . . . but
they
said
the same thing about Greenspan.
So let’s look at the actual historical record to determine how well
the Fed has done.

Initially,
Milton Friedman and
Ben
Bernanke have both said that the Federal Reserve
caused (or at least
failed to cure) the Great Depression through its poor monetary policy.

Moreover, one of the Fed’s main justification has been that it can
provide a “counter-cyclical” balance. In other words, during boom times
it can put on the brakes (”take the punch bowl away right as the party
gets started”), and during busts it can get things moving again. But
as economist Jane D’Arista has shown, the Fed has
failed miserably at that task:

Jane D’Arista, a reform-minded economist and retired professor
with a deep conceptual understanding of money and credit [has a]
devastating critique of the central bank.
The Federal
Reserve, she explains, has failed in its most essential function:
to serve as the balance wheel that keeps economic cycles from going
too far. It is supposed to be a moderating force in American capitalism
on the upside and on the downside, the role popularly described
as “leaning against the wind.” By applying its leverage on the available
supply of credit, the Fed can slow down a boom that is dangerously
overwrought or, likewise, stimulate the economy if it is sinking
into recession. The Fed’s job, a former chairman once joked,
is “to take away the punch bowl just when the party gets going.”
Economists know this function as “counter-cyclical policy.”

The Fed not
only lost control, D’Arista asserts, but its policy actions have
unintentionally become “pro-cyclical”–encouraging financial excesses
instead of countering the extremes. “The pattern that has
developed over the last two decades,” she wrote in 2008, “suggests
that relying on changes in interest rates as the primary tool of
monetary policy can set off pro-cyclical foreign capital flows that
tend to reverse the intended result of the action taken. As a result,
monetary policy can no longer reliably perform its counter-cyclical
function–its raison d’être–and its attempts to do so may exacerbate
instability.”…

The Fed is also supposed to act as a regulator for banks and their
affiliates, but
failed miserably in that role as well.

In a pointed attack on the US Federal Reserve, [BIS and its chief
economist William White] said central banks would not find it easy
to “clean up” once property bubbles have burst…

Nor does it exonerate the watchdogs. “How could such a huge shadow
banking system emerge without provoking clear statements of official
concern?”

“The fundamental cause of today’s emerging problems was excessive
and imprudent credit growth over a long period. Policy interest
rates in the advanced industrial countries have been unusually low,”
[White] said.

The Fed and fellow central banks instinctively cut rates lower
with each cycle to avoid facing the pain. The effect has been to
put off the day of reckoning…

“Should governments feel it necessary to take direct actions
to alleviate debt burdens, it is crucial that they understand one
thing beforehand. If asset prices are unrealistically high, they
must fall. If savings rates are unrealistically low, they must rise.
If debts cannot be serviced, they must be written off.

“To deny this through the use of gimmicks and palliatives will
only make things worse in the end,” he said.

As PhD economist Steve Keen has
pointed out, the Fed (along with Treasury) has also given money
to the wrong people to kick-start
the economy.

(2) claims that
the Federal Reserve System saddles the U.S. government and American
people with trillions of dollars in unnecessary debt (that would
not be incurred if the government took back the “power to coin money”
granted to the government itself in the Constitution).

Even so, it shows that the Federal Reserve has performed very poorly
indeed.

His verdict on former Fed Chairman
Alan Greenspan is as astute as it is merciless. A telling moment
comes when Ritholtz shows how Greenspan drew the wrong conclusion from
the first crisis during his tenure, the crash of ‘87.

“What the astute student learns from the history of speculative frenzies
is that the 1987 crash was
a unique aberration,” Ritholtz writes. It was a rare
combination of a sizzling equity market, a (dangerously) innovative
product called portfolio insurance and some antiquated stock-exchange
plumbing that together created a short, brutal drop in an otherwise
strong economy, he says.

“Greenspan completely missed this point,” he says. “The 1987 crash
was the rare exception, not the rule.”

The upshot: Greenspan would respond to
crisis after crisis -- from LTCM to the popping dot-com bubble -- with
the same mistaken treatment: more liquidity and lower rates. The Greenspan
Put was born.

Bailing out LCM

In September 1998, we saw the failure of a single lightly
regulated U.S. hedge fund, Long-Term Capital Management. This
threatened our financial system, and the Fed cut rates
preemptively--making popular the term “Greenspan put.” (A put is a
contract that gives the owner the right to sell assets at a fixed
price, and it is often used to lock in profits or limit losses. So,
if your assets fell in value, Greenspan would effectively buy them
or--literally--put a floor under their value. Stocks, for example,
are underpinned by future expected company earnings; the value today
of those future flows goes up when interest rates are lower--so any
cut by the Fed is welcomed by stock-market investors.) In a bright
shining moment, markets realized that the Fed was prepared, through
interest rate cuts and loose credit, to do whatever it took to bail
out financiers facing large losses. Risk-taking without fear for the
consequences became the name of the game, at least for our largest
financial players: They get the upside if things go well, and the
Fed will limit their downside when the speculative frenzy of the day
finally runs out of steam.

This environment helped feed the technology bubble--and bust. And
this led to further rate cuts--championed by Bernanke, then working
under Greenspan. Those 2001 rate cuts--and subsequent decisions to
hold interest rates low--encouraged our housing bubble. The phrase
“Bernanke put” is now catching hold, meaning an explosive burst of
bailouts, liquidity provision, and supportive fiscal stimulus far
larger than anything implemented under Greenspan. But Bernanke’s
mega-put is just one further step along a path that was established
long ago, back in 1913 when the Federal Reserve was founded.

Over the past century, we have moved away from a system where
bank shareholders and senior executives paid dearly for bad
management--and toward a system where fired bank bosses make off
with fortunes or launch brilliant political careers. No one is on
the financial hook, other than the taxpayer. Consider the case of
Citigroup, a seriously troubled bank. Chuck Prince, the CEO who fell
flat on his face, walked away with close to $100 million. Win
Bischoff, former chairman and interim CEO of Citigroup during the
debacle, has just been appointed chairman of Lloyds Banking Group in
the United Kingdom--reflecting the high esteem in which he is
apparently still held. And Robert Rubin, Treasury secretary under
Clinton, made over $100 million as board member and chair of
Citigroup. In an interview late in 2008, he brushed off any
responsibility for the mismanagement of anything. And so, our
recurring financial crises are not isolated random events; they
emerge from a pattern of private and public sector behavior. Enabled
by the Fed, our system’s tolerance for risk is out of control. This
is an increasingly dangerous system. It is only a matter of time
until it collapses again.

...But the capital inadequacy did not evolve by itself. It was created
by the policy by the Federal Reserve. Geithner seems to have forgotten
the stated official views of the Fed under Alan Greenspan who said in
a 1998 testimony before Congress:

We should note that were banks required by the market, or their
regulator, to hold 40% capital against assets as they did after
the Civil War, there would, of course, be far less moral hazard
and far fewer instances of fire-sale market disruptions. At the
same time, far fewer banks would be profitable, the degree of financial
intermediation less, capital would be more costly, and the level
of output and standards of living decidedly lower. Our current economy,
with its wide financial safety net, fiat money, and highly leveraged
financial institutions, has been a conscious choice of the American
people since the 1930s. We do not have the choice of accepting the
benefits of the current system without its costs.

The risk of systemic market failure was a conscious choice of Fed monetary
policy that the American people did not have much say in. Greenspan,
notwithstanding his denial of responsibility in helping throughout the
1990s to unleash the equity bubble, had this to say in 2004 in hindsight
after the bubble burst in 2000: "Instead of trying to contain a putative
bubble by drastic actions with largely unpredictable consequences, we
chose, as we noted in our mid-1999 congressional testimony, to focus
on policies to mitigate the fallout when it occurs and, hopefully, ease
the transition to the next expansion."

By the "next expansion", Greenspan meant the next bubble, which manifested
itself in housing. He did not heed the dire warnings in 2000. The "wide
financial safety net" that Greenspan relied on had holes big enough
to drive a Mack truck through. By 2008, Greenspan was forced to admit
to Congress that he erred in his faith in the self-regulatory regime
of banks.

The Federal Reserve, through its extensive
network of consultants, visiting scholars, alumni and staff economists,
so thoroughly dominates the field of economics that real criticism of
the central bank has become a career liability for members of the profession,
an investigation by the Huffington Post has found.

This dominance
helps explain how, even after the Fed failed to foresee the greatest
economic collapse since the Great Depression, the central bank has largely
escaped criticism from academic economists. In the Fed's thrall, the
economists missed it, too.

"The Fed has a lock on the economics world," says Joshua Rosner,
a Wall Street analyst who correctly called the meltdown. "There is no
room for other views, which I guess is why economists got it so wrong."

One critical way the Fed exerts control on academic economists is
through its relationships with the field's gatekeepers. For instance,
at the Journal of Monetary Economics, a must-publish venue for rising
economists, more than half of the editorial board members are currently
on the Fed payroll -- and the rest have been in the past.

The Fed failed to see the housing bubble as it happened, insisting
that the rise in housing prices was normal. In 2004, after "flipping"
had become a term cops and janitors were using to describe the way to
get rich in real estate, then-Federal Reserve Chairman Alan Greenspan
said that "a national severe price distortion [is] most unlikely." A
year later, current Chairman Ben Bernanke said that the boom "largely
reflect strong economic fundamentals."

The Fed also failed to sufficiently regulate major financial institutions,
with Greenspan -- and the dominant economists -- believing that the
banks would regulate themselves in their own self-interest.

Despite all this, Bernanke has been nominated for a second term by
President Obama.

In the field of economics, the chairman remains a much-heralded figure,
lauded for reaction to a crisis generated, in the first place, by the
Fed itself. Congress is even considering legislation to greatly expand
the powers of the Fed to systemically regulate the financial industry.

Paul Krugman, in
Sunday's New York Times magazine, did his own autopsy of economics,
asking "How Did Economists Get It So Wrong?" Krugman concludes that
"[e]conomics, as a field, got in trouble because economists were seduced
by the vision of a perfect, frictionless market system."

So who seduced them?

The Fed did it.

Three Decades of Domination

The Fed has been dominating the profession for about three decades.
"For the economics profession that came out of the [second world] war,
the Federal Reserve was not a very important place as far as they were
concerned, and their views on monetary policy were not framed by a working
relationship with the Federal Reserve. So I would date it to maybe the
mid-1970s," says University of Texas economics professor -- and Fed
critic -- James Galbraith. "The generation that I grew up under, which
included both Milton Friedman on the right and Jim Tobin on the left,
were independent of the Fed. They sent students to the Fed and they
influenced the Fed, but there wasn't a culture of consulting, and it
wasn't the same vast network of professional economists working there."

But by 1993, when former Fed Chairman Greenspan provided the House
banking committee with a breakdown of the number of economists on contract
or employed by the Fed, he reported that 189 worked for the board itself
and another 171 for the various regional banks. Adding in statisticians,
support staff and "officers" -- who are generally also economists --
the total number came to 730. And then there were the contracts. Over
a three-year period ending in October 1994, the Fed awarded 305 contracts
to 209 professors worth a total of $3 million.

Just how dominant is the Fed today?

The Federal Reserve's Board of Governors employs 220 PhD economists
and a host of researchers and support staff, according to a Fed spokeswoman.
The 12 regional banks employ scores more. (HuffPost placed calls to
them but was unable to get exact numbers.) The Fed also doles out millions
of dollars in contracts to economists for consulting assignments, papers,
presentations, workshops, and that plum gig known as a "visiting scholarship."
A Fed spokeswoman says that exact figures for the number of economists
contracted with weren't available. But, she says, the Federal Reserve
spent $389.2 million in 2008 on "monetary and economic policy," money
spent on analysis, research, data gathering, and studies on market structure;
$433 million is budgeted for 2009.

That's a lot of money for a relatively small number of economists.
According to the American Economic Association, a total of only 487
economists list "monetary policy, central banking, and the supply of
money and credit," as either their primary or secondary specialty; 310
list "money and interest rates"; and 244 list "macroeconomic policy
formation [and] aspects of public finance and general policy." The National
Association of Business Economists tells HuffPost that 611 of its roughly
2,400 members are part of their "Financial Roundtable," the closest
way they can approximate a focus on monetary policy and central banking.

Auerbach found that in 1992, roughly 968 members of the AEA designated
"domestic monetary and financial theory and institutions" as their primary
field, and 717 designated it as their secondary field. Combining his
numbers with the current ones from the AEA and NABE, it's fair to conclude
that there are something like 1,000 to 1,500 monetary economists working
across the country. Add up the 220 economist jobs at the Board of Governors
along with regional bank hires and contracted economists, and the Fed
employs or contracts with easily 500 economists at any given time. Add
in those who have previously worked for the Fed -- or who hope to one
day soon -- and you've accounted for a very significant majority of
the field.

Auerbach concludes that the "problems associated with the Fed's
employing or contracting with large numbers of economists" arise "when
these economists testify as witnesses at legislative hearings or as
experts at judicial proceedings, and when they publish their research
and views on Fed policies, including in Fed publications."

Gatekeepers On The Payroll

The Fed keeps many of the influential editors of prominent acade>The
pharmaceutical industry has similarly worked to control key medical
journals, but that involves several companies. In the field of economics,
it's just the Fed.

Being on the Fed payroll isn't just about the money, either. A relationship
with the Fed carries prestige; invitations to Fed conferences and offers
of visiting scholarships with the bank signal a rising star or an economist
who has arrived.

Affiliations with the Fed have become the oxygen of academic life
for monetary economists. "It's very important, if you are tenure track
and don't have tenure, to show that you are valued by the Federal Reserve,"
says Jane D'Arista, a Fed critic and an economist with the Political
Economy Research Institute at the University of Massachusetts, Amherst.

Robert King, editor in chief of the Journal of Monetary Economics
and a visiting scholar at the Richmond Federal Reserve Bank, dismisses
the notion that his journal was influenced by its Fed connections. "I
think that the suggestion is a silly one, based on my own experience
at least," he wrote in an e-mail. (His full response is at the bottom.)

Galbraith, a Fed critic, has seen the Fed's influence on academia
first hand. He and co-authors Olivier Giovannoni and Ann Russo found
that in the year before a presidential election, there is a significantly
tighter monetary policy coming from the Fed if a Democrat is in office
and a significantly looser policy if a Republican is in office. The
effects are both statistically significant, allowing for controls, and
economically important.

They submitted a paper with their findings to the Review of Economics
and Statistics in 2008, but the paper was rejected. "The editor assigned
to it turned out to be a fellow at the Fed and that was after I requested
that it not be assigned to someone affiliated with the Fed," Galbraith
says.

Publishing in top journals is, like in any discipline, the key to
getting tenure. Indeed, pursuing tenure ironically requires a kind of
fealty to the dominant economic ideology that is the precise opposite
of the purpose of tenure, which is to protect academics who present
oppositional perspectives.

And while most academic disciplines and top-tier journals are controlled
by some defining paradigm, in an academic field like poetry, that situation
can do no harm other than to, perhaps, a forest of trees. Economics,
unfortunately, collides with reality -- as it did with the Fed's incorrect
reading of the housing bubble and failure to regulate financial institutions.
Neither was a matter of incompetence, but both resulted from the Fed's
unchallenged assumptions about the way the market worked.

Even the late Milton Friedman, whose monetary economic theories heavily
influenced Greenspan, was concerned about the stifled nature of the
debate. Friedman, in a 1993 letter to Auerbach that the author quotes
in his book, argued that the Fed practice was harming objectivity: "I
cannot disagree with you that having something like 500 economists is
extremely unhealthy. As you say, it is not conducive to independent,
objective research. You and I know there has been censorship of the
material published. Equally important, the location of the economists
in the Federal Reserve has had a significant influence on the kind of
research they do, biasing that research toward noncontroversial technical
papers on method as opposed to substantive papers on policy and results,"
Friedman wrote.

Greenspan told Congress in October 2008 that he was in a state of
"shocked disbelief" and that the "whole intellectual edifice" had "collapsed."
House Committee on Oversight and Government Reform Chairman Henry Waxman
(D-Calif.) followed up: "In other words, you found that your view of
the world, your ideology, was not right, it was not working."

"Absolutely, precisely," Greenspan replied. "You know, that's precisely
the reason I was shocked, because I have been going for 40 years or
more with very considerable evidence that it was working exceptionally
well."

But, if the intellectual edifice has
collapsed, the intellectual infrastructure remains in place. The same
economists who provided Greenspan his "very considerable evidence" are
still running the journals and still analyzing the world using the same
models that were incapable of seeing the credit boom and the coming
collapse.

Rosner, the Wall Street analyst who foresaw the crash, says that
the Fed's ideological dominance of the journals hampered his attempt
to warn his colleagues about what was to come. Rosner wrote a strikingly
prescient paper in 2001 arguing that relaxed lending standards and
other factors would lead to a boom in housing prices over the next several
years, but that the growth would be highly susceptible to an economic
disruption because it was fundamentally unsound.

He expanded on those ideas over the next few years, connecting the
dots and concluding that the coming housing collapse would wreak havoc
on the collateralized debt obligation (CDO) and mortgage backed securities
(MBS) markets, which would have a ripple effect on the rest of the economy.
That, of course, is exactly what happened and it took the Fed and the
economics field completely by surprise.

"What you're doing is, actually, in order to get published, having
to whittle down or narrow what might otherwise be oppositional or expansionary
views," says Rosner. "The only way you can actually get in a journal
is by subscribing to the views of one of the journals."

When Rosner was casting his paper on CDOs and MBSs about, he knew
he needed an academic economist to co-author the paper for a journal
to consider it. Seven economists turned him down.

"You don't believe that markets are efficient?" he says they asked,
telling him the paper was "outside the bounds" of what could be published.
"I would say 'Markets are efficient when there's equal access to information,
but that doesn't exist,'" he recalls.

The CDO and MBS markets froze because, as the housing market crashed,
buyers didn't trust that they had reliable information about them --
precisely the case Rosner had been making.

Together, the two papers offer a better analysis of what led to the
crash than the economic journals have managed to put together - and
they were published by a non-PhD before the crisis.

Not As Simple As A Pay-Off

Economist
Rob Johnson serves on the UN Commission of Experts on Finance and
International Monetary Reform and was a top economist on the Senate
banking committee under both a Democratic and Republican chairman. He
says that the consulting gigs shouldn't be looked at "like it's a payoff,
like money. I think it's more being one of, part of, a club -- being
respected, invited to the conferences, have a hearing with the chairman,
having all the prestige dimensions, as much as a paycheck."

The Fed's hiring of so many economists can be looked at in several
ways, Johnson says, because the institution does, of course, need talented
analysts. "You can look at it from a telescope, either direction. One,
you can say well they're reaching out, they've got a big budget and
what they're doing, I'd say, is canvassing as broad a range of talent,"
he says. "You might call that the 'healthy hypothesis.'"

The other hypothesis, he says, "is that they're essentially using
taxpayer money to wrap their arms around everybody that's a critic and
therefore muffle or silence the debate. And I would say that probably
both dimensions are operative, in reality."

To get a mainstream take, HuffPost called monetary economists at
random from the list as members of the AEA. "I think there is a pretty
good number of professors of economics who want a very limited use of
monetary policy and I don't think that that necessarily has a negative
impact on their careers," said Ahmed Ehsan, reached at the economics
department at James Madison University. "It's quite possible that if
they have some new ideas, that might be attractive to the Federal Reserve."

Ehsan, reflecting on his own career and those of his students, allowed
that there is, in fact, something to what the Fed critics are saying.
"I don't think [the Fed has too much influence], but then my area is
monetary economics and I know my own professors, who were really well
known when I was at Michigan State, my adviser, he ended up at the St.
Louis Fed," he recalls. "He did lots of work. He was a product of the
time...so there is some evidence, but it's not an overwhelming thing."

There's definitely prestige in spending a few years at the Fed that
can give a boost to an academic career, he added. "It's one of the better
career moves for lots of undergraduate students. It's very competitive."

Press officers for the Federal Reserve's board of governors provided
some background information for this article, but declined to make anyone
available to comment on its substance.

The Fed's Intolerance For Dissent

When dissent has arisen, the Fed has dealt with it like any other
institution that cherishes homogeneity.

Take the case of Alan Blinder. Though he's squarely within the mainstream
and considered one of the great economic minds of his generation, he
lasted a mere year and a half as vice chairman of the Fed, leaving in
January 1996.

Rob Johnson, who watched the Blinder ordeal, says Blinder made the
mistake of behaving as if the Fed was a place where competing ideas
and assumptions were debated. "Sociologically, what was happening was
the Fed staff was really afraid of Blinder. At some level, as an applied
empirical economist, Alan Blinder is really brilliant," says Johnson.

In closed-door meetings, Blinder did what so few do: challenged assumptions.
"The Fed staff would come out and their ritual is: Greenspan has kind
of told them what to conclude and they produce studies in which they
conclude this. And Blinder treated it more like an open academic debate
when he first got there and he'd come out and say, 'Well, that's not
true. If you change this assumption and change this assumption and use
this kind of assumption you get a completely different result.' And
it just created a stir inside--it was sort of like the whole pipeline
of Greenspan-arriving-at-decisions was
disrupted."

It didn't sit well with Greenspan or his staff. "A lot of senior
staff...were pissed off about Blinder -- how should we say? -- not playing
by the customs that they were accustomed to," Johnson says.

And celebrity is no shield against Fed excommunication. Paul Krugman,
in fact, has gotten rough treatment. "I've been blackballed from the
Fed summer conference at Jackson Hole, which I used to be a regular
at, ever since I criticized him," Krugman said of Greenspan in a 2007
interview with
Pacifica Radio's Democracy Now! "Nobody really wants to cross him."

An invitation to the annual conference, or some other blessing from
the Fed, is a signal to the economic profession that you're a certified
member of the club. Even Krugman seems a bit burned by the slight. "And
two years ago," he said in 2007, "the conference was devoted to a field,
new economic geography, that I invented, and I wasn't invited."

Three years after the conference, Krugman won a Nobel Prize in 2008
for his work in economic geography.

One Journal, In Detail

The Huffington Post reviewed the mastheads of the American Journal
of Economics, the Journal of Economic Perspectives, Journal of Economic
Literature, the American Economic Journal: Applied Economics, American
Economic Journal: Economic Policy, the Journal of Political Economy
and the Journal of Monetary Economics.

HuffPost interns Googled around looking for resumes and otherwise
searched for Fed connections for the 190 people on those mastheads.
Of the 84 that were affiliated with the Federal Reserve at one point
in their careers, 21 were on the Fed payroll even as they served as
gatekeepers at prominent journals.

At the Journal of Monetary Economics,
every single member of the editorial board is or has been affiliated
with the Fed and 14 of the 26 board members are presently on the Fed
payroll.

After the top editor, King, comes senior associate editor Marianne
Baxter, who has written papers for the Chicago and Minneapolis banks
and was a visiting scholar at the Minneapolis bank in '84, '85, at the
Richmond bank in '97, and at the board itself in '87. She was an advisor
to the president of the New York bank from '02-'05. Tim Geithner, now
the Treasury Secretary, became president of the New York bank in '03.

The senior associate editors: Janice C Eberly was a Fed visiting-scholar
at Philadelphia ('94), Minneapolis ('97) and the board ('97). Martin
Eichenbaum has written several papers for the Fed and is a consultant
to the Chicago and Atlanta banks. Sergio Rebelo has written for and
was previously a consultant to the board. Stephen Williamson has written
for the Cleveland, Minneapolis and Richmond banks, he worked in the
Minneapolis bank's research department from '85-'87, he's on the editorial
board of the Federal Reserve Bank of St. Louis Review, is the co-organizer
of the '09 St. Louis Federal Reserve Bank annual economic policy conference
and the co-organizer of the same bank's '08 conference on Money, Credit,
and Policy, and has been a visiting scholar at the Richmond bank ever
since '98.

And then there are the associate editors. Klaus Adam is a visiting
scholar at the San Francisco bank. Yongsung Chang is a research associate
at the Cleveland bank and has been working with the Fed in one position
or another since '01. Mario Crucini was a visiting scholar at the Federal
Reserve Bank of New York in '08 and has been a senior fellow at the
Dallas bank since that year. Huberto Ennis is a senior economist at
the Federal Reserve Bank of Richmond, a position he's held since '00.
Jonathan Heathcote is a senior economist at the Minneapolis bank and
has been a visiting scholar three times dating back to '01.

Ricardo Lagos is a visiting scholar at the New York bank, a former
senior economist for the Minneapolis bank and a visiting scholar at
that bank and Cleveland's. In fact, he was a visiting scholar at both
the Cleveland and New York banks in '07 and '08. Edward Nelson was the
assistant vice president of the St Louis bank from '03-'09.

Esteban Rossi-Hansberg was a visiting scholar at the Philadelphia
bank from '05-'09 and similarly served at the Richmond, Minneapolis
and New York banks.

Pierre-Daniel Sarte is a senior economist at the Richmond bank, a
position he's held since '96. Frank Schorfheide has been a visiting
scholar at the Philadelphia bank since '03 and at the New York bank
since '07. He's done four such stints at the Atlanta bank and scholared
for the board in '03. Alexander Wolman has been a senior economist at
the Richmond bank since 1989.

Here is the complete response from King, the journal's editor in
chief: "I think that the suggestion is a silly one, based on my own
experience at least. In a 1988 article for AEI later republished in
the Federal Reserve Bank of Richmond Review, Marvin Goodfriend (then
at FRB Richmond and now at Carnegie Mellon) and I argued that it was
very important for the Fed to separate monetary policy decisions (setting
of interest rates) and banking policy decisions (loans to banks, via
the discount window and otherwise). We argued further that there was
little positive case for the Fed to be involved in the latter: broadbased
liquidity could always be provided by the former. We also argued that
moral hazard was a cost of banking intervention.

"Ben Bernanke understands this distinction well: he and other members
of the FOMC have read my perspective and sometimes use exactly this
distinction between monetary and banking policies. In difficult times,
Bernanke and his fellow FOMC members have chosen to involve the Fed
in major financial market interventions, well beyond the traditional
banking area, a position that attracts plenty of criticism and support.
JME and other economics major journals would certainly publish exciting
articles that fell between these two distinct perspectives: no intervention
and extensive intervention. An upcoming Carnegie-Rochester conference,
with its proceeding published in JME, will host a debate on 'The Future
of Central Banking'.

"You may use only the entire quotation above or no quotation at all."

Auerbach, shown King's e-mail, says it's just this simple:
"If you're on the Fed payroll there's a
conflict of interest."

One such petition occurred in 1875, in the Ukraine’s Chigrin District.
An outside agitator had tried to organize resistance, to stir up trouble,
with the local peasantry. After being found out and expelled, a petition
asking for Czar Alexander II’s forgiveness was drafted by the locals.

"How could we, simple, backward people, not believe in the kindness
of our beloved monarch, when the whole world attests to it, when we
know of his love and his trust for his people, his concern for them."

If you think that such bootlicking fawning obsequiousness could never
happen in the United States, freedom’s home, the land where the people
rule and the rulers serve, you haven’t watched a Congressional hearing
with a US Federal Reserve Board chairman recently.

It
happens two or three times a year, and it’s always the same. After an
exchange of pleasantries, the Fed chairman delivers his opening statement.
During the Alan Greenspan era, this invariably meant about a half hour
of indecipherable economic gobbledygook flowing thick like molasses;
the financial markets could understand what was being said, and frequently
reacted violently in response, but few average citizens could. (Hillary
Clinton recently announced that, if elected, she wanted Greenspan to
head a commission studying the foreclosure crisis, although, in her
continuing effort to prove herself just one of the guys downing shots
and beer nuts around the bar in working class Pennsylvania, she admitted
that "I never understand what he's saying.")

Then the committe members are permitted to question the great oracle.
Sometimes, you can tell that the solon is just reading something written
by somebody on his staff who once passed an economics course. Sometimes,
since the great augur was obviously in possession of wisdom in all matters
of the physical domain, the questions might be related to areas totally
beyond the chairman’s purview, like, "Tell me, Mr Chairman, what’s your
opinion, chains or studded snow tires?" Frequently, like a local asking
for the blessing of a Mafia Don for the success of a new enterprise,
the questions would be totally parochial, like, "Tell me, Mr Chairman,
isn’t the real problem with our economy the lack of funding for post
offices in southwestern Wyoming?", asked by, of course, the representative
from southwestern Wyoming.

But the main phenomenon of this process was that the questions were
almost always asked with the maximum amount of awe, deference and respect,
and, invariably, the questioner would not get a straight answer to his
question.

Based principally on the DeLay-Abramoff affair
with its muddy torrent of graft, Thomas Frank denounces highly emotionally
but limpidly the agenda of the conservative right concerning the State
and its government, as well as their ideology of selfishness and greed.

The core of US conservatism is the interests of business. These interests
are mightily more important than their `free market' evangel. Mechanisms
like tariff walls, public subsidies, monopolies, no-bid contracts or
patent protections, will be adopted without any resistance if they enhance
profits.

The conservative right sees the liberal State as a perversion, as
a corruption of private interests (taxes), not as an instrument to service
the population as a whole.

When they took power, they sabotaged the working of the government
by appointing ferocious opponents of State agencies (EPA, FDA, SEC)
at their head. They even created anti-agencies (OIRA, Council on Competitiveness).

For them, all public services should be subjected to the market system,
because that is the most efficient way of ruling. In other words, those
services have to be managed by private interests.

For Thomas Frank, the result of these policies was a rip-off. The
institutions created for the protection of the population became institutions
for the exploitation of the population (arms industry, anti-terrorism,
administration of Iraq, recovery of hurricane Katrina ...).

One of the main targets of the conservatives is the Welfare State.
The money flows of the welfare programs should be privately managed,
thereby generating colossal commissions for a bunch of Wall Street managers,
while in the meantime `defunding the left'.

For Thomas Frank, this is a sure way for turning US politics into
a plutocracy and concomitantly a `bought' government.

Through lobbyism and pure propaganda for the agenda of the Right,
conservatism itself became a business with monster fees for the preachers.

A US senator asked a few years ago: `Have you missed the government?'

If the government had not intervened heavily in the huge banking
crisis of the last years, the whole capitalist system would have been
turned into a desert, an enormous Great Depression for many years to
come. The other side of the coin would have been an astonishing handover
of all political, economic and financial world powers to the East (China).

This book is a must read for all those who want to understand the
world we live in.

N.B. James K. Galbraith treated the same all important issues in
a more theoretical way in his formidable book `The Predator State'.

Exposing the Deliberate Mismanagement of a Flawed Political Philosophy,
May 4, 2009

Reading Thomas Frank's The Wrecking Crew has been like finding a key
piece to a jigsaw puzzle. My other research led me to believe the things
Frank writes about were going on. Frank provides the proof without having
to do the first hand research.

In a nutshell, Frank proves the Republican/Conservative approach
to governing is not to govern at all. If you are someone who believes
there is essentially no difference between the two major US political
parties, then this book will change your mind.

My personal preference is I want to vote for a political party whose
approach is to govern by balancing the interests of all parties concerned.
This approach, to me, is more likely to produce effective and efficient
government. In other words, the party might have a preference for one
group over another, but the party operates on the premise it will be
more likely to be re-elected if it shows itself to be even handed.

Republicans/Conservatives take an entirely different approach. According
to Frank's book, Republicans govern only to benefit business and their
supporters, not the public as a whole. More on this thought in a moment.

Having recommended in my own book independent voters make contributions
to both parties in order to see what each party says about the other,
I was especially interested in Frank's description
of conservative direct mail fund raising and its enabling of the physical
(not intellectual) growth of what passes for conservatism. Frank describes the origins of that phenomenon and how the money
is used not just for political purposes but also to feather the nests
of those who conduct the operations.

Frank also does a marvelous job of describing the origins and driving
philosophies of people such as Jack Abramoff, Grover Norquist and Tom
Delay and the creation of the intensive lobbying efforts enabled by
those flawed philosophies.

Some prime elements of that flawed philosophy include the following.
Govern on behalf of business and your campaign
contributors at the expense of the public at large, rather than balancing
the interests of all. Hollow out and suppress the activities
of regulatory agencies by putting political appointees in place who
will to keep the agencies from doing their jobs. Reward your campaign
contributors by outsourcing more and more government functions and awarding
the contracts to your contributors. Incur excessive amounts of debt
so the government will be forced to shrink and push off its welfare
and education programs to churches (or at least that is the whispered
plan with a wink. Whether such a plan was actually intended to be supported
is debatable.)

Show me some examples, you say? How about failure to regulate financial
markets to prevent either the speculation in oil prices or the sub-prime
meltdown? How about passing drug legislation without negotiation requirements
or credit card bills written by credit card companies? How about FEMA
and "Heckuva job, Brownie"? How about Monica Goodling (a graduate of
Pat Robertson's Regent University) using political litmus tests for
attorneys to work for the Justice Department? How about no-bid contracts
to Halliburton and using Blackwater mercenaries?

I also liked Frank's cataloging of something I've heard before. If
a conservative politician fails to govern well, conservatives will blame
not the flawed philosophy. Instead, conservatives will say of the politician
that he/she was not a "true conservative".

Overall, I shake my head at the lack of perspective of the people
expressing these philosophies. They are like people who complain about
the mess the mud between the logs of the log cabin makes inside the
cabin, never realizing the purpose of the mud and the damage removing
the mud will create.

Thanks to The Wrecking Crew, the flaws of this philosophy have never
been more evident.

"I am afraid we may have, in the near
future, friendly fascism. And I do not use the term lightly. I grew
up under fascism, in Franco’s Spain, and if nothing else, I recognize
fascism when I see it. And we are seeing a growing fascism with
a working-class base in the U.S. This is why we cannot
afford to see Obama fail. But his staff and advisors are doing a
remarkable job to achieve this. Ideologues such as chief-of-staff
Rahm Emanuel (who, when a congressman, was the most highly funded
by Wall Street) and his brother, Ezekiel Emanuel (who did indeed
write that old people should have a lower priority for health care
spending) are leading the country along a wrong path."

Vincent Navarro
writes an amazingly insightful political analysis of health care reform
and the Obama Adminstration. This is as we would expect, since Navarro,
is an M.D., Ph.D., and professor of Health Policy at The Johns Hopkins
University and editor-in-chief of the International Journal of Health
Services.

But then he goes on to end his essay with this remarkably bad prescription.

"Given this reality, it seems to me that the role of the left is
to initiate a program of social political agitation and rebellion
(I applaud the health professionals who disrupted the meetings of
the Senate Finance Committee), following the tactics of the Civil
Rights and anti-Vietnam War movements of the 1960s and 1970s. It
is wrong to expect and hope that the Obama administration will change.
Without pressure and agitation, not much will be done."

The Will to Power has a bewitching siren call. It offers simple
solutions to complex problems. It provokes the cycle of problem
- reaction - solution, and the eye for an eye approach that 'makes the whole world blind.'

"Communism and fascism or nazism, although poles apart in their
intellectual content, are similar in this, that both have emotional
appeal to the type of personality that takes pleasure in being submerged
in a mass movement and submitting to superior authority." James
A. C. Brown

And yet, like most dark powers, it decimates and destroys who pick up
the sword, and lays waste to them, their country, and their children.

This is the lesson of history, the abyss of madness into which a great
leader can bring a nation once it loses its sense of proportion, that
people in their passionate desire for power often forget.

The subprime mortgage meltdown was at the heart of what’s been called
the Great Recession of 2008. It caused more than a million Americans to
lose their homes and brought Wall Street to its knees. A new documentary
opening today in New York takes on the subprime crisis, tracking its
roots on Wall Street and Washington and profiling some of its victims,
mainly African American families who lost their homes. We play
highlights and speak with filmmakers Leslie and Andrew Cockburn.
[includes rush transcript]
Transcript
This is a rush transcript. Copy may not be in its final form.

AMY GOODMAN:
The economy has a long way to recover from what’s been called the
Great Recession of 2008. At the heart of the meltdown was the subprime
mortgage crisis that caused more than a million Americans to lose their
homes and brought Wall Street to its knees.

A new documentary that’s opening today in New York takes on the
subprime collapse, tracking its roots on Wall Street and Washington and
profiling some of its victims, mainly African American families who lost
their homes.

American Casino is directed by Leslie Cockburn, who wrote and
produced the documentary with her husband, journalist and author Andrew
Cockburn. They join us today in our firehouse studio.

But we first will turn to an excerpt of the
film, which begins by looking at how deregulation of the financial
sector laid the groundwork for the economic meltdown. This is American Casino.

MICHAEL
GREENBERGER: To understand why this is like a gambling
casino, you have to understand what’s at stake here. On a December
evening, December 15th, 2000, around 7:00, Phil Gramm, Republican
senator of Texas, then chair of the Senate Finance Committee, walked
to the floor of the Senate and introduced a 262-page bill as a rider
to the 11,000-page appropriation bill, which excluded from
regulation the financial instruments that are probably most at the
heart of the present meltdown.

He not excluded them from all federal regulation, but he excluded
them from state regulation as well, which is important because these
instruments could be viewed to be gambling instruments, where you’re
betting on whether people will or will not pay off their loans. And
he announced at the time that this measure would be a boon to the
American economy and be a boon to Wall Street, because they would be
freed of any supervision in this regard. And that lack of
supervision freed Wall Street to essentially shoot itself in both
feet.

DAVID ATTASANI:
I worked for four companies on Wall Street. Three of them don’t
exist anymore. I don’t think anything is really permanent in life. I
mean, sure, my grandfather worked for the same company for, you
know, twenty-some-odd years in the steel mills of Pittsburgh, maybe
thirty years. I don’t know. But he worked for the same company his
whole life. Nothing’s permanent anymore. The stock market goes
south, the banks going out of business. It’s just the way people in
America live. I don’t think anything I’ve done propelled or
inhibited it. I don’t think. No, I don’t feel any responsibility for
this mess at all.

MARK PITTMAN:
It really started getting heated in 2004, 2005. Mortgage rates
kept dropping for prime mortgages, you know, the ones that most
people get, and that made the others much more valuable, because
they offered much more yield. When you have that much cash flow
that’s extra, you can siphon off a whole lot more fees, and that is
— you know, it’s all about money. Subprime in 2005 and 2006, the
issuance was about $800 billion total. It’s a river of cash. $800
billion will buy a lot of houses and do a lot of things, and you
could tap into that. Your fees on that might be four percent. OK,
four percent of — $32 billion.

DAVID ATTASANI:
If there’s more demand for homes and more people securitizing
mortgages, we would sell more bonds. And it could be a billion to
two billion to five billion, you know, to ten billion a month.

MARK PITTMAN:
This is a Lehman Brothers bond done in early 2006. If you look
here, you can tell how many mortgages are delinquent sixty days or
delinquent more than ninety days, how many — how much money they’ve
already lost and how much real estate they’ve already taken back
that’s in foreclosure. That’s real estate they’ve already taken back
and not sold yet. As you can see, you know, this is not going well.
They’ve got $800 million, and, you know, they’ve got 31 percent
that’s more than ninety days delinquent.

REP. HENRY WAXMAN: Dr. Greenspan, you had an
ideology, you had a belief, that free, competitive — and this is
your statement: “I do have an ideology. My judgment is that free,
competitive markets are by far the unrivaled way to organize
economies. We’ve tried regulation. None meaningfully worked.” That
was your quote.

You had the authority to prevent irresponsible lending practices
that led to the subprime mortgage crisis. You were advised to do so
by many others. And now our whole economy is paying its price. Do
you feel that your ideology pushed you to make decisions that you
wish you had not made?

ALAN GREENSPAN:
Well, remember that what an ideology is a conceptual
framework with the way people deal with reality. Everyone has one.
You have to. To exist, you need an ideology. The question is whether
it is accurate or not. And what I’m saying to you is, yes, I’ve
found a flaw. I don’t know how significant or permanent it is, but
I’ve been very distressed by that fact.

But if I may, may I just finish an answer to the question
previously posed?

REP. HENRY WAXMAN: You found a flaw in the
reality —-

ALAN GREENSPAN:
Flaw in the model that I perceived as the critical functioning
structure that defines how the world works, so to speak.

REP. HENRY WAXMAN: In other words, you found that
your view of the world, your ideology, was not right. It was not
working.

ALAN GREENSPAN:
That it had a -— precisely. No, that’s precisely the reason I
was shocked, because I’ve been going for forty years or more with
very considerable evidence that it was working exceptionally well.

Like a typical member of Politburo Greenspan surrounded himself by cronies
who adhere to his personal "party line".

Target fixation is a process by which the brain is focused
so intently on an observed object that awareness of other obstacles
or hazards can diminish...The term "target fixation" may have been borrowed
from World War II fighter pilots, who spoke of a tendency to want to
fly into targets during a strafing run…. Target fixation may
also refer to a phenomenon where a skydiver may forget to pull the ripcord
because he or she is so focused on the landing area.(From Wikipedia,
the free encyclopedia)

... ... ...

Evidence of Fed Target Fixation

A speech by Rajan “Has Financial
Development Made the World Riskier?” aufficient liqu the past 18 years.
I believe that the Greenspan doctrine, if I may call it that, has reflected
the Chairman's analysis and deeply held belief that private interest
and technological change, interacting in a stable macroeconomic environment,
will advance the general welfare.

July 19, 2009 | www.ritholtz.com

This week’s
Barron’s has Randall Forsyth going a bit postal on the Usual Suspects:

“With so many miscreants participating in arguably the biggest
financial catastrophe in history, it’s all but impossible to point
to the chief perpetrator.

In truth, there was a suspension of disbelief all down the line:
by mortgage brokers who arranged loans for delusional borrowers
who bought houses they both knew they couldn’t afford; bankers who
collected, pooled and sliced and diced the junk mortgages into triple-A
securities; ratings agencies who provided that Good Housekeeping
Seal of Approval to those defective products; investors who credulously
bought these mortgage-backed securities with gilt-edged ratings
and junk-bond yields; sellers of credit-default swaps who never
thought they’d have to pay off on the insurance they’d written.
And don’t forget Fannie and Freddie, which leveraged the implicit
(and later explicit) backing of Uncle Sam to use cheap credit to
balloon their balance sheets. And it was all fine, of course, because
house prices never went down.

No less an authority than Alan Greenspan, the former Federal
Reserve chairman, saw no problem with this because, firstly, scattering
all these loans to the wind meant the risk was dispersed and therefore
nobody needed to worry about the all these dubious loans threatening
the financial health of any one institution. Moreover, there was
no need to worry about bubbles; though they inevitably burst, the
damage can be contained by reinflating a new one.

In that, Greenspan had empirical
evidence on his side, after having reflated successive burst bubbles
over his tenure. The Fed had done just that after
the 1987 stock-market crash, which led to the commercial real-estate
and junk-bond booms and busts of the late ’80s. And after the dot-com
bust of 2001 (which was helped importantly by Fed pumping to stave
off the supposed Y2K threat), Greenspan countered by slashing rates
to 1% by 2003 and leaving them at preternaturely low levels for
a couple of years, which inflated the housing bubble.”

Note what Forsyth writes: Not that there are no villains, but that
its hard to pick the worst of the bunch out of all the miscreants involved.
Still, it seems he is nominating Greenie as the front runner.

And yet
some other people continue to think there were no villains in all
of this. Some folks have suggested its simply a case of defining deviancy
down, but I believe the more likely explanation is that its yet another
Atlas-addled brain unable to process evidence that conflicts
with now hard-wired ideolology.

Call it yet another case of cognitive dissonance . . .

Source:
It’s Good to Be Goldman
Randall Forsyth
Barron’s, JULY 20, 2009
http://online.barrons.com/article/SB124786956635760403.html

The way I see this distorted situation is that when someone does
come along (in banking or government) who can whip it (whip it good)
they are slandered or screwed over like Brooksley E. Born (who could
whip it): "As the financial crisis of 2008 gained momentum, newspapers
began reporting on what might be some of its causes, including the adversarial
relationship Greenspan, Rubin and Levitt had with Brooksley Born, [11]
with Greenspan leading the opposition, and how Born's recommendations
were suppressed.[9] She is retired from Arnold & Porter and until recently
had declined to comment on the unfolding crisis and her efforts to rein
in the growing market for derivatives. "The market grew so enormously,
with so little oversight and regulation, that it made the financial
crisis much deeper and more pervasive than it otherwise would have been."
The disagreement has been described as a classic Washington turf war.
She now laments the influence of Wall Street lobbyists on the process
and the refusal of regulators to discuss even modest reforms"

As recently as two years ago consumers were buying so many goods
on credit that the domestic savings rate was zero. (Financing the U.S.
Government’s budget deficit with foreign central bank recycling of the
dollar’s balance-of-payments deficit actually produced a negative
2% savings rate.) During these Bubble Years savings by the wealthiest
10% of the population found their counterpart in the debt that the bottom
90% were running up. In effect, the wealthy were lending their surplus
revenue to an increasingly indebted economy at large.

Today, homeowners no longer can re-finance their mortgages and compensate
for their wage squeeze by borrowing against rising prices for their
homes. Payback time has arrived – paying back bank loans, whose volume
has been augmented to include accrued interest charges and penalties.
New bank lending has hit a wall as banks are limiting their activity
to raking in amortization and interest on existing mortgages, credit
cards and personal loans.

Many families are able to remain financially afloat by running down
their savings and cutting back their spending to try and avoid bankruptcy.
This diversion of income to pay creditors explains why retail sales
figures, auto sales and other commercial statistics are plunging vertically
downward in almost a straight line, while unemployment rates soar toward
the 10% level. The ability of most people to spend at past rates has
hit a wall. The same income cannot be used for two purposes. It cannot
be used to pay down debt and also for spending on goods and services.
Something must give. So more stores and shopping malls are becoming
vacant each month. And unlike homeowners, absentee property investors
have little compunction about walking away from negative equity situations
– owing creditors more than the property is worth.

Over two-thirds of the U.S. population are homeowners, and real estate
economists estimate that about a quarter of U.S. homes are now in a
state of negative equity as market prices plunges below the mortgages
attached to them. This is the condition in which Citigroup and AIG found
themselves last year, along with many other Wall Street institutions.
But whereas the government absorbed their losses “to get the economy
moving again” (or at least to help Congress’s major campaign contributors
to recover), personal debtors are in no such favored position. Their
designated role is to help make the banks whole by paying off the debts
they have been running up in an attempt to maintain living standards
that their take-home pay no longer is supporting.

. For this attempt to spoil the party, she was excoriated and isolated
by an old-boys' mob that included Alan Greenspan, Robert Rubin, Lawrence
Summers and Gary Gensler. Incredibly enough, Gensler, an Obama appointee,
now holds Born's old job as chair of the CFTC.

More than a decade and several meltdowns later, the Obama administration's
88-page white paper is ambiguous on the subject of whether and how

As
Ezra Klein puts it: “When evaluating a particular financial regulation
proposal, ask yourself this question: Would these regulations have worked
if Alan Greenspan hadn’t wanted to implement them?” That’s a good question,
although it’s a bit unfair: if you posit
a regulator who doesn’t believe in regulation, then virtually any regulatory
scheme is bound to fail. This is why Fox and Klein argue
for ironclad rules that don’t leave room for discretion. In addition,
though, I think we also need to think about how to make sure we get
regulators who are not cheerleaders for or captives of the financial
services industry.

Former Fed chairman Alan Greenspan
writes in the Financial Times that, if only stock prices would keep
going higher, we might have a chance at a sustained
economic recovery.

The rise in global stock prices from early March to mid-June is
arguably the primary cause of the surprising positive turn in the
economic
environment. The $12,000bn of newly created corporate equity
value has added significantly to the capital buffer that supports
the debt issued by financial and non-financial companies. Corporate
debt, as a consequence, has been upgraded and yields have fallen.
...
Global stock markets have rallied so far and so fast this year that
it is difficult to imagine they can proceed further at anywhere
near their recent pace. But what if, after a correction, they proceeded
inexorably higher? That would bolster global balance sheets with
large amounts of new equity value and supply
banks with the new capital that would allow them to step up
lending. Higher share prices would also lead to increased household
wealth and spending, and the rising market value of existing corporate
assets (proxied by stock prices) relative to their replacement cost
would spur new capital investment...

PLEASE!! JUST STOP!!

You can't blow more bubbles just by writing an occasional op-ed piece
in the Financial Times, an organization that, for their own perhaps
perverse reasons, still allows you to air your thoughts to a wide audience
on a regular basis.

Maybe the Financial Times still hasn't gotten over the whole "transfer
of global superpower status" from six or seven decades ago and sees
this as an opportunity to highlight some of the reasons why, in the
decades ahead, this power will be shifting again.

Maybe not...

Back to the Maestro, as he explains his thinking on perpetually rising
asset prices.

I recognise that I accord a much larger economic role to equity
prices than is the conventional wisdom. From my perspective, they
are not merely an important leading indicator of global business
activity, but a major contributor to that activity, operating primarily
through
balance
sheets. My hypothesis will be tested in the year ahead.
If shares fall back to their early spring lows or worse, I would
expect the “green shoots” spotted in recent weeks to wither.

Stock prices, to be sure, are affected by the usual economic gyrations.
But, as I noted in March, a significant
driver of stock prices is the innate human propensity to swing between
euphoria and fear, which, while heavily influenced by economic events,
has a life of its own. In my experience, such episodes
are often not mere forecasts of future business activity, but major
causes of it.

It's too bad that not too many people listen to what 'ol Greenie has
to say anymore because, in his later years, he's offering more insight
into why he did what he did.

As evidenced by that last paragraph above, he really believed that a
bubble-based economy was the right way to go.

He goes on to talk about inflation, deflation, and political pressure
on the Fed.

For the benevolent scenario above to play out, the short-term dangers
of deflation and longer-term dangers of inflation have to be confronted
and removed. Excess capacity is temporarily suppressing global prices.
But I see inflation as the greater future challenge. If political
pressures prevent central banks from reining in their inflated balance
sheets in a timely manner, statistical
analysis suggests the emergence of inflation by 2012;
earlier if markets anticipate a prolonged period of elevated money
supply. Annual price inflation in the US is significantly correlated
(with a 3½-year lag) with annual changes in money supply per unit
of capacity.

While the statistical analysis referred to might be woefully underestimating
the timeframe for inflation (look at what oil prices have done lately,
just based on "green shoots"), the comments on political pressure are
probably on the mark.

That will be Ben Bernanke's big test over the next year - to do what's
in the best interest of the economy in the long-term despite there being
a mid-term election approaching.

As for the demands of Congress and the White House during Greenspan's
tenure, he learned his lesson well from the early-retirement of his
unpopular (but now highly regarded) predecessor at the central bank,
Paul Volcker:

Political pressure is a constant - if you want to be reappointed, keep
the easy money coming.

6/20/2009 | CalculatedRisk

CR Note: This is a guest post by Mathew Padilla of the
Mortgage Insider blog. All opinions expressed are Matt's.

A book review by Mathew Padilla for Calculated Risk.

Count the following among the most accurate titles ever written:
Nasdaq’s Peak was Greenspan’s. The title introduced a 2001
essay by James Grant, author of newsletter
Grant’s Interest
Rate Observer, in which the author addresses former Fed Chief Alan
Greenspan’s approach to the ‘90s stock bubble: “He seeded it, accommodated it, celebrated it and defended it
from those who believed they saw it turn into a bubble.”

The essay is an opening salvo against Greenspan to be followed by
three other works that eviscerate the Maestro, the Federal Reserve and
U.S. monetary policy in Grant’s late 2008 book Mr. Market Miscalculates:
The Bubble Years and Beyond, which is a compilation of his essays
celebrating the 25th anniversary of his newsletter. (I confess I submitted
the review to Calculated Risk this month because I just finished reading
the book.)

In the Nasdaq’s Peak essay Grant deconstructs Greenspan’s
March 6, 2000 speech before the Boston College Conference on the New
Economy. Greenspan praised the “revolution in information technology”
including how managers formulated decisions with “real-time” information
and that reduced uncertainty, allowing them to better control inventories.
Grant delivers one of his many wry lines:

Thanks to clarity afforded by instantaneous communications, Cisco
Systems had to write off only $2.25 billion in excess inventories
during its third fiscal quarter, in addition to just $1.17 billion
in restructuring and other special charges. … Lucent, Corning, Nortel
and JDS Uniphase have been devastated by one of the greatest misallocations
of investment capital outside the chronicles of the Soviet Gosplan.
Who can conceive of the size of this waste had there been no e-mail?

It’s the misallocation of capital that gets at the heart of Grant’s
criticism of both Greenspan and the Fed. Grant saw Greenspan as the Chairman of Perpetual Intervention, juicing
the money supply

When a big hedge fund had a serious hiccup

When computers might go bonkers over two-digit dates.

After Nasdaq tanked. But the former chief saw no need to raise
rates to stem speculative excesses. (Recall the 2001 essay is before
the most pernicious bubble of all.) Greenspan practiced a lopsided
monetary policy.

Compounding his folly, Greenspan was slow to react to the Nasdaq
crash and start lowering rates when boom turned to bust in the second
half of 2000, Grant writes, adding: “(B)ecause information technology
was an absolute and unqualified good thing, it followed that it could
not be held responsible for a bad thing – for instance, the bottom falling
out of capital investment and, therefore, out of the GDP growth rate.”

That was Grant annoyed. Grant disgusted comes across in a September
13, 2002 essay, Monetary Regime Change, in which Grant’s prose
oozes with repugnance as he picks apart Greenspan’s speech that year
at the “monetary jamboree” of the Kansas City Federal Reserve Bank in
Jackson Hole, Wyo. “Alan Greenspan washed his hands of responsibility
for the bubble he said he could not have pricked even if he had noticed
it floating above his desk on a string.” Again we are talking about
the tech bubble – a warning that Greenspan was a deeply flawed policymaker.
Grant goes on:

Following is a speculation on the outlines of a post-Greenspan monetary
system. It is supported by some of the historical works that the
chairman can read in the well-deserved retirement he should have
taken starting in about 1996. We say “post-Greenspan” because, we
believe, the Jackson Hole Speech will raise the odds against his
reappointment (his current term expires in 2004), speed the day
of his departure and reduce his policy-making influence for a long
as he remains in office.

Grant was right about Greenspan not being reappointed, but wrong about
his waning influence. In his final years, Greenspan fueled a pernicious
explosion in credit, and he provided intellectual
cover to politicians either ideologically opposed to regulation or too
preoccupied with other matters to get to it. The essayist
also was prescient but a little early with this in 2002: “Only one of
the troubles with bubbles is that, after they pop, ultra-low interest
rates and extraordinary rates of credit expansion lose their stimulative
potency. The rate of creation of new yen by the Bank of Japan stands
at 26.1% year-over-year, but this outpouring has yielded no appreciable
reflationary results.” Grant was exactly right, but after a property
bubble, not a stock-market bubble.

Greenspan is the lighting rod,
but monetary policy is the storm. Grant writes since the late 19th century
to their creators, each monetary system suited the ages. “But none lasted
much longer than a generation. The system in place since 1971 is the
worldwide paper-dollar system.” Grant takes this idea and runs with
it in Mission Creeps, a November 7, 2003 essay that takes stock
of the Federal Reserve on the eve of its 90th anniversary. “The Federal
Reserve would be unrecognizable to the men who conceived it.” The law
creating the Fed defined its purposes as follows, “to provide for the
establishment of the Federal Reserve banks, to furnish and elastic currency,
to afford means of rediscounting commercial paper and to establish a
more effective supervision of banking in the United States, and for
other purposes.”

The founders, including Sen. Carter Glass (D.Va.), feared bank runs
and their potential to disrupt commerce. They envisioned a central bank
that could keep the banking system liquid. But they lived in the era
of the gold standard, and never, ever dreamed of an expanding money
supply designed to boost employment. Balancing full employment and appropriate
inflation came later – the Fed and Congress found uses for the original
act’s “and for other purposes.” Grant’s strongest ammunition is fired
at the very idea of a central bank’s power to steer an economy, and
all the myriad actors in it, by comparing economics to the hard science
of physics in 2003:

Both use quantitative methods to build predictive models, but physics
deals with matter; economics confronts human beings. And because
matter doesn’t talk back or change its mind in the middle of a controlled
experiment or buy high with the hope of selling even higher, economists
can never match the predictive success of the scientists who wear
lab coats. … Gov. Ben S. Bernanke is one of those true believers,
as he reiterated last month in a lecture at the London School of
Economic. “If all goes as planned,” said Bernanke, getting off on
the wrong foot, “the changes in financial asset prices and returns
induced by the actions of monetary policymakers lead to changes
in economic behavior that the policy was trying to achieve.” If
all went according to plan, the LSE would be teaching case studies
in the triumphs of the Soviet economy.

In yet another essay, There ought to be Deflation, in January
14, 2005, Grant builds on the idea of a monetary policy as a source
of economic distortion. He quotes Friedrich von Hayek, who, while accepting
the Nobel price for economics more than 20 years ago, said:

The continuous injection of additional amounts of money at points
of the economic system where it creates a temporary demand which
must cease when the increase of money stops or slows down, together
with the expectation of a continuing rise in prices, draws labor
and other resources into employment which can last only so long
as the increase of the quantity of money continues at the same rate
– or perhaps even only so long as it continues to accelerate at
a given rate.

And that is exactly what happened when Greenspan
cut rates in the 2000s. Workers flooded into subprime lenders, construction
companies, Home Depots, and on and on.

Grant bemoans,
in more than one essay, the death of the gold standard. In his view
a fixed currency would constrain both the Fed and the federal government.
It might even have prevented a war of choice in Iraq, since what cannot
be funded cannot be done. But fixed currencies have their
disadvantages, writes another Nobel laureate, Paul Krugman, in another
book tackling our current woes, his updated
The Return of Depression Economics and the Crisis of 2008. A currency
that is allowed to fall benefits an economy in recession since its exports
become cheaper, Krugman argues. He’s also a proponent of a flexible
currency giving a central bank freedom to expand money and combat unemployment.

Curiously, Krugman has a chapter in his book dubbed Greenspan’s
Bubbles, but he does not address the Greenspan conundrum: what
to do about the risk a Fed chairman will over stimulate asset prices
while doing nothing to stop credit abuses. Until that problem is addressed
I side with Grant and Hayek – expansionary
monetary policy is dangerous.

In all of Mr. Market Miscalculates, I have but one quibble
with Grant’s views. He cites the “socialization of risk” as encouraging
reckless corporate behavior. The problem began with FDIC insurance and
culminated in Greenspan’s interventions, including the orderly dissolution
of hedge fund Long Term Capital Management. Grant’s case is that banks
are more willing to lend to corporate cowboys if they think government
will bail them out, or the market overall.

An alternative view is that FDIC insurance has been a key element
among government initiatives that maintained safety and soundness in
banking for some 50 years. It wasn’t until President Reagan initiated
the anti-regulation era that insured institutions went bonkers – S&Ls
binged on junk bonds and commercial real estate. Even now, with all
that has happened, consumers are not lining up at insured banks in an
all out panic – before FDIC insurance some good banks failed on mere
rumors of trouble.

And moral hazard did not fuel the excesses of the era just ended.
As an example, noninsured, nonbank New Century Financial secured more
than $15 billion in credit lines from bigger banks in housing’s heyday.
No one thought the subprime generator was too big to fail. And as soon
as it wobbled, New Century found its credit cut off, and it fell into
the abyss. This is the real issue with the modern era -- capital flows
quickly, at times too quickly, into and out of any venture anywhere
in the world.

On the whole, there is much genius in Grant’s observations. And his
book covers more than what I touched on here. He gives a modern take
on value investing, illuminates Wall Street’s mortgage fantasies, and
more. As for a solution to the Greenspan problem, it is not Grant’s
style to offer one. He never explicitly says the country should return
to the gold standard or hack some appendages off the Federal Reserve.
Grant is subtler, and more general. He simply warns us: change is coming.

And this brings us to Alan Greenspan, whom I've known for over 50
years and who I regarded as one of the best young business economists.
Townsend-Greenspan was his company. But the trouble is that he had been
an Ayn Rander. You can take the boy out
of the cult but you can't take the cult out of the boy. He actually had instruction, probably pinned on the wall: 'Nothing
from this office should go forth which discredits the capitalist system.
Greed is good.'

However, unlike someone like Milton, Greenspan was quite streetwise.
But he was overconfident that he could handle anything that arose. I
can remember when some of us -- and I remember there were a lot of us
in the late 90s -- said you should do something about the stock bubble.
And he kind of said, 'look, reasonable men
are putting their money into these things -- who are we to second guess
them?' Well, reasonable men are not reasonable when you're in the bubbles
which have characterized capitalism since the beginning of time.

But now Greenspan admits he was wrong.

Because we had, instead of three standard deviations storm, a six
standard deviation storm. Well, we did have something unprecedented.
I think looking for scapegoats and blame can be left to the economic
historian. But, at the bottom, with eight years of no regulation from
the second Bush administration, from the day that the new SEC chairman
-- Harvey Pitt -- said 'I'm going to run a kinder and gentler SEC,'
every financial officer knew they weren't going to be penalized.

Self regulation never worked as far as macroeconomic events -- whether
we're talking about post-Napoleonic War business cycles or the big south
sea bubble back in Isaac Newton's time, up to today's time. The pendulum
just swings back in the other direction.

In a superb front-page article in today's New York Times,
"Taking
a Hard Look at a Greenspan Legacy," Peter S. Goodman treats his
readers to a banquet of former Federal Reserve Chairman Alan Greenspan's
oracular pronouncements in favor of deregulating derivative markets
-- Yes, those unregulated, absurdly inflated "swaps" and other exotic
debt instruments that are largely responsible for crippling the financial
system of our civilization.

According to the article, Mr. Greenspan told a Congressional committee
in the mid-1990s: "Risks in financial markets, including derivative
markets, are being regulated by private parties. There is nothing involved
in federal regulation per se which makes it superior to market regulation."
Oh, Really? I don't know what history books Mr. Greenspan reads -- maybe
he should put down Atlas Shrugged for a moment and read about
the causes of the Great Depression, or even the causes of the more recent
dot-com bust or the failure of WorldCom, Tyco, Adelphia, etc. Or, better
yet, maybe Greenspan should return the "Enron Prize" that "Kenny Boy"
Lay gave him in 2000 and read up on the causes of the Enron collapse.
I guess it is too much to ask a multimillionaire economist to lower
himself and pick up a book about how American society has actually worked
in the past, instead of relying on his ideological wet dreams.

Greenspan knows that banking regulations, like the 1933 Glass-Steagall
Act, did not come forth because the financial system was humming along,
but rather, they emerged out of a financial crisis similar to the one
we are experiencing right now.

Goodman's piece shows that Mr. Greenspan
is an ideologue. His devotion to the free-market Ayn Rand-Milton Friedman
creed is as fanatical as a Conquistador or a Maoist.
Although Greenspan refused to grant an interview for the article, he
is still gallivanting around the country telling his acolytes at high-paid
speaking engagements: "Risk management can never achieve perfection."
His assessment of the current financial meltdown is exactly like George
Bush's assessment of the damage caused by Hurricane Katrina: "Oops,
sorry -- I'll try to get it right next time." Well, that attitude is
simply not good enough anymore -- if it ever was. We expect more from
our public officials now.

Ironically, the economic crisis Greenspan helped create offers us
an opportunity. It comes at the perfect time for an electoral referendum
on the disastrous eight-year reign of Bush the Younger and his Republican
cheerleaders, as well as a repudiation of neo-liberal, laissez-faire,
right-wing ideology that has been rammed down the nation's throat for
three decades. I think most Americans now realize that Greenspan's libertarian
worldview is nothing more than greed posing as public policy.

And yet with all of the evidence that Wall Street could not be trusted
-- the "golden parachutes" for executives who crash their companies,
the insider trading and fraudulent over-valuation of stocks, the labyrinthine
network of off-shore accounts and "special purpose entities" that look
a lot like money laundering, and so on -- Mr. Greenspan, at a time when
derivatives were infecting the international banking system like a financial
AIDS virus, had this to say in 2004 : "Not only have individual financial
institutions become less vulnerable to shocks from underlying risk factors,
but also the financial system as a whole has become more resilient."

Those words should be Alan Greenspan's epitaph -- they should be
inscribed on his tombstone when he joins Ayn Rand and Milton Friedman
in the great free-market utopia in the sky.

The sociologist/economist, James O'Connor, argued long ago that an
"accumulation crisis" of the magnitude we're now seeing historically
always ushers in a "legitimation crisis" as millions of people slowly
begin to realize that the smart white men in pin-striped suit (like
Greenspan) who they trusted to run the nation's most important financial
institutions have been lying to them all along, and are, in reality,
nothing but a bunch of white-collar criminals free of any ethical constraints.
That's what happened after the Great Depression: two crises, one economic,
the other political. And just look at the behavior of the AIG executives
who took a weeklong vacation partying and golfing and getting pedicures
and manicures (and who knows what else) at a beachside resort lavishing
on themselves $500,000 AFTER receiving the $85 billion bail out from
the American taxpayers. What are we to make of people like that? And
Alan Greenspan still says we can trust these guys?

No wonder the Republicans do not want us to look back on the recent
history that brought us to this point. Given that Ronald Reagan, the
free-market avatar who started the ball rolling, appointed Alan Greenspan
to be Fed Chair, he, more than any other individual, embodies the market
fundamentalist philosophy that has brought the nation to its knees.

Hank Paulson and Ben Bernanke are trying to pretend that they have
the situation under control, but this thing is so huge and complex and
international in scope they do not have a clue about how to begin addressing
the crisis. They're not riding a "tiger," they're chasing a thousand
tigers in the middle of a hurricane. They are play acting as if they
are running things so the stock market is reassured. Well, today's 678
point drop in the Dow indicates that these men have no credibility,
hence, proof that the "legitimacy crisis" continues.

I think it's safe to say that Alan Greenspan
will go down in history, along with George W. Bush, as a reckless and
radical proponent of failed laissez-faire policies, as well as one of
the worst public officials in American history.

October 20, 2005

The editor of The Economist is currently on NPR. Responding to a
question from a listener about Alan Greenspan's role in the Bush deficits,
he deflected it by saying that Greenspan is just in charge of monetary
policy, so it's really on Bush, but perhaps could have used his "bully
pulpit" more. The dishonesty here, of course, is implying that Greenspan
has consistently opposed Bush's fiscal policy but not loudly enough.
Er, no. As the country's Randian-in-chief is let out to pasture, let
his
profoundly embarrassing argument in 2001 that the possibility that
the national debt would be paid off too quickly was a good reason for
Bush's unpaid-for upper-class tax cuts be mentioned as much as possible.

Apr 17, 2009 | NYT (Reuters)

The Federal Reserve allowed the global credit crisis to happen and
must be redrawn as a tough regulator to stop big financial institutions
from taking excessive risks, prominent Wall Street economist Henry Kaufman
said on Friday.

The world is "now in the midst of the worst financial crisis since
the Second World War," Kaufman said in a speech titled "Who is Primarily
Responsible for the Credit Crisis?" he gave to a conference in New York.

"I am convinced that the misbehavior
of some would have been much rarer -- and far less damaging to our economy
-- if the Federal Reserve and, to a lesser extent, other supervisory
authorities, had measured up to their responsibilities," Kaufman said.

Kaufman became known for correctly forecasting higher inflation and
interest rates when he was chief economist with Salomon Brothers in
the 1970s and 1980s. During that time, he acquired the moniker "Doctor
Doom" among financial market watchers and is well known as an expert
on monetary policy and how financial markets work.

"At a minimum, the Fed's sensitivity to financial excesses must be
improved," Kaufman said.

SAYS GREENSPAN FAILED TO WARN ABOUT RISKS

Kaufman directly criticized former Federal Reserve Chairman Alan
Greenspan for not using his position to dissuade big banks and others
from taking big risks.

"Alan Greenspan spoke about irrational exuberance only as a theoretical
concept, not as a warning to the market to curb excessive behavior,"
Kaufman said. "It is difficult to believe that recourse to moral suasion
by a Fed chairman would be ineffective."

Partly because the Fed did not strongly
oppose the repeal in 1999 of the Depression-era Glass-Steagall Act,
more large financial conglomerates that were "too big to fail" have
formed, Kaufman said, citing a factor that has made the global credit
crisis especially acute.

"Financial conglomerates have become more and more opaque, especially
about their massive off-balance-sheet activities," he said. "The Fed
failed to rein in the problem."

Banks' exposure via hedge funds and structured investment vehicles,
known as SIVs, to assets that turned bad have burdened them with trillions
of dollars of write-downs and losses since the credit crisis erupted
in mid-2007.

The U.S. central bank is largely to blame for the banking system's
ballooning exposure to such risks, Kaufman said.

Now the Fed should act as a regulator to strictly oversee big financial
institutions and impose "constraints on their assets and profit growth,"
he said.

However, Kaufman praised the central bank's many emergency measures
to combat the global financial crisis by supporting securities markets
to get credit flowing again.

For the central bank's "resourcefulness and innovativeness in working
to revive the credit market ... the Fed deserves to be commended," Kaufman
said. "Even so, these actions came after the crisis had gained considerable
momentum."

To outline his fears about the U.S. economy, Raghuram Rajan picked
a tough crowd.

It was August 2005, at an annual gathering of high-powered economists
at Jackson Hole, Wyo. -- and that year they were honoring Alan Greenspan.
Mr. Greenspan, a giant of 20th-century economic policy, was about to
retire as Federal Reserve chairman after presiding over a historic period
of economic growth.

Mr. Rajan, a professor at the University of Chicago's Booth Graduate
School of Business, chose that moment to deliver a paper called "Has
Financial Development Made the World Riskier?"

His answer: Yes.

Mr. Rajan quickly came under attack as an antimarket Luddite, wistful
for old days of regulation. Today, however, few are dismissing his ideas.
The financial crisis has savaged the reputation of Mr. Greenspan and
others now seen as having turned a blind eye toward excessive risk-taking.

More

He says he had planned to write about how financial developments
during Mr. Greenspan's 18-year tenure made the world safer. But the
more he looked, the less he believed that. In the end, with Mr. Greenspan
watching from the audience, he argued that disaster might loom.

Incentives were horribly skewed in the financial sector, with workers
reaping rich rewards for making money, but being only lightly penalized
for losses, Mr. Rajan argued. That encouraged financial firms to invest
in complex products with potentially big payoffs, which could on occasion
fail spectacularly.

He pointed to "credit-default swaps," which act as insurance against
bond defaults. He said insurers and others were generating big returns
selling these swaps with the appearance of taking on little risk, even
though the pain could be immense if defaults actually occurred.

Mr. Rajan also argued that because banks were holding a portion of
the credit securities they created on their books, if those securities
ran into trouble, the banking system itself would be at risk. Banks
would lose confidence in one another, he said: "The interbank market
could freeze up, and one could well have a full-blown financial crisis."

Two years later, that's essentially what happened.

Many of the big names in Jackson Hole
weren't ready to hear the warning. Former Treasury Secretary Lawrence
Summers, famous among economists for his blistering attacks, told the
audience he found "the basic, slightly lead-eyed premise of [Mr. Rajan's]
paper to be misguided."

The 45-year-old Mr. Rajan is an unlikely dissident. Born in Bhopal,
India, he had a childhood marked by stints in Indonesia, Sri Lanka and
Belgium, as his civil-servant father rose through the ranks. In high
school, he came across the work of British economist John Maynard Keynes,
who became his intellectual hero.

He was "helping the world out of recession," Mr. Rajan says of Lord
Keynes. "For a person growing up in a developing country, you sort of
believe that there has to be a better way."

Joining the University of Chicago's business school in 1991, Mr.
Rajan established himself as a rising star. He won the first Fischer Black Prize in 2003 for the person under
40 who has contributed most to the theory and practice of finance.
Later that year he became the IMF's chief economist,
the youngest person and first non-Westerner in that position.

The Jackson Hole contretemps followed by a few months another set
of attacks on Mr. Rajan for a study he co-wrote at the IMF that concluded
foreign aid didn't help developing countries grow. Mr. Rajan says the
twin controversies didn't deter him. At the IMF, he pushed the research
department to focus on financial-sector issues, and continued to sound
alarm bells about financial-market risks.

By summer 2007, as the crisis began unfolding in earnest, Fed bank
presidents Janet Yellen and Gary Stern were citing Mr. Rajan's critiques
in their speeches.

With the economy heading toward the deepest recession since World
War II, Mr. Rajan believes, the government needs to be more forceful
in its efforts to right the still-teetering banking sector, deciding
bank by bank which ones deserve capital injections and which need to
die. Otherwise, banking problems will deepen, as they did in Japan in
the 1990s, he says, and delay an economic recovery.

Mr. Rajan is now focused on coming up with ways to avoid a regulatory
backlash akin to what happened during the Great Depression, when governments
around the world threw up protectionist barriers and clamped down on
financial markets.

Instead of heavy regulation, he says,
the incentives of Wall Streeters need to change so that punishments
for losing money are in line with rewards for earning it.

At the start of 2008, he suggested that bonuses that financial workers
make during boom times should be kept in escrow accounts for a period
of time. If the firm experienced big losses later, those accounts would
be drained.

Facing withering criticism over the bonuses paid out in the boom,
financial giant UBS and Wall Street firm Morgan Stanley have recently
announced they're adopting policies along the lines of what Mr. Rajan
proposed.

Mr. Rajan also urges other safeguards. Along with Chicago colleagues
Anil Kashyap and Harvard economist Jeremy Stein, he's come up with a
plan to create a form of financial-catastrophe insurance that firms
would buy into.

When he presented the insurance idea at last year's Jackson Hole
confab, the reaction was different than back in 2005. Finnish central-bank
governor Erkki Liikanen, recalling the weaknesses Mr. Rajan had spotted
in the system back then, said: "I don't dare criticize you. That is
all."

William White’s tussle with Alan Greenspan is spilling into their
retirements as world leaders meet in London to try to prevent the next
financial meltdown.

White challenged the former Federal Reserve chairman’s mantra that
central bankers can’t effectively slow the causes of asset bubbles when
he was chief economist at the Bank for International Settlements.

As heads of state gather for tomorrow’s Group of 20 summit, several
former central bankers and regulators are advising them to advance the
same arguments White has made for more than a decade: raise interest
rates when credit expands too fast and force banks to build up cash
cushions in fat times to use in lean years.

"We started worrying about this at the same time that Alan Greenspan
started worrying about irrational exuberance" in 1996, said White, a
Canadian who has remained in Basel, Switzerland, since retiring from
the BIS in June. "The difference was he stopped worrying about it, or
at least he stopped worrying about it publicly, and we didn’t."

Chiefs of the world’s 20 biggest economies, including U.S. President
Barack Obama and Chinese President Hu Jintao, will debate how the first
contraction in the global economy since the Great Depression could have
been avoided, and how to change systems for managing growth and regulating
financial industries.

White, now 65, suddenly has company. His approach is reflected in
position papers for the G-20 written by Jacques de Larosiere, former
head of the International Monetary Fund and the Bank of France, and
former Fed Chairman Paul Volcker.

Financial Stability

"Concerns for financial stability are relevant not just in times
of financial crisis, but also in times of rapid credit expansion and
increased use of leverage that may lead to crises," a panel led by Volcker
said in a January report for the coalition of former central bankers,
finance ministers and academics known as the Group of Thirty.

Stability matters because today’s economic stress could quickly lead
to social unrest, which is what happened in the 1930s, White said in
an interview across from his old office in Basel. He described how his
father was killed in 1944 fighting Adolf Hitler’s forces in France near
the town of Caen in Normandy. White was born on May 17, 1943, in Kenora,
Ontario, about 400 miles north of Minneapolis.

In this crisis, the U.S. government and the Fed alone have spent,
lent or guaranteed US$12.8 trillion to try to prop up the banking industry
and overall economy to stem the longest recession since the 1930s. The
World Bank said last month that the global economy will probably shrink
this year for the first time since World War II.

15 Years

White’s warnings that credit risks were building up started while
he was at the Bank of Canada, where he was deputy governor from 1988
to 1994. They were his constant refrain for more than 15 years, said
Michael Mussa, senior fellow at the Peterson Institute in Washington
and former IMF chief economist.

"I met Bill in 1991 or 1992, and we were already talking about this
back then," Mussa said.

In 1994, White joined the BIS, a counterparty for the world’s central
banks and a forum for top policy makers and finance officials. He became
head of the monetary and economic department in 1995. The BIS also houses
the Basel Committee on Banking Supervision, which sets international
bank capital requirements.

Jackson Hole

White took his argument directly to Greenspan on Aug. 28, 2003, at
the Kansas City Fed’s annual meeting in Jackson Hole, Wyoming. Claudio
Borio, head of research for White’s department, prepared for questions
as White wrote his notes out in longhand at the Jackson Lake Lodge in
Grand Teton National Park.

"Claudio said to me quite rightly, ‘We cannot miss this chance, everybody
is going to be there,’" White said. Borio, still at the BIS, declined
to comment.

Greenspan was unmoved by the presentation and said he pointed out
that the Fed had tried and failed to stem a surge in stock prices by
raising its target for the Federal Funds rate by 300 basis points in
1994. A basis point is 0.01 percentage point. He still isn’t convinced
White’s monetary policy plan would work, he said.

"There has never been an instance, of which I’m aware, that leaning
against the wind was successfully done," Greenspan, 83, said in a Feb.
27 telephone interview. He added that spotting a bubble is easy. What’s
hard is predicting when it will pop.

‘Out of Whack’

Greenspan, who retired as Fed chairman in 2006, did broadly agree
with White’s position on safety margins for banks, he said.

"It has always bothered me that our capital requirements are so low,"
he said. "We do not have an adequate cushion."

Mark Gertler, a New York University economics professor who has collaborated
on research with Fed Chairman Ben Bernanke, Greenspan’s successor, said
that the U.S. housing boom and bust weren’t caused by low interest rates
in 2003 and 2004. The problem stemmed from the decline in subprime mortgage
lending standards and from leaving investment banks essentially unregulated
even as they held mortgages and issued short-term liabilities like commercial
banks, he said.

"The first-order cause of this crisis was the regulatory system was
way out of whack," Gertler said. "It’s not the case that you can get
at this alone with interest-rate policy; it really requires smart regulatory
policy."

White’s policy plans recently have been endorsed through words and
actions. Axel Weber, president of Germany’s central bank and a European
Central Bank board member, said in a Feb. 10 speech in Malaysia that
monetary authorities should consider raising rates if risk increases
in financial markets, even if there is no short-term inflation-fighting
reason to do so.

UBS, Credit Suisse

Bank capital regulation changes like the ones White promotes were
adopted in December by Switzerland. The country set up new rules for
UBS AG and Credit Suisse Group AG requiring them, by 2013, to hold between
50% and 100% more capital than the minimum 8% of risk-weighted assets
under Basel rules. They could dip into the shock absorber in hard times.
The regulator also instituted a leverage ratio, or a maximum amount
of debt each bank could hold relative to its capital.

White will have influenced the discussion at the G-20 meeting, which
he’s not attending, as part of a committee headed by the ECB’s former
chief economist, Otmar Issing, which made recommendations to the German
government. White also presented his views at a Feb. 18 conference in
Toronto aimed at forming the Canadian government’s proposals.

Japan’s Example

White watched from the Bank of Canada as shares and real- estate
prices soared in Japan in the 1980s. Asset prices then crashed, growth
ground almost to a halt and unemployment climbed.

"It’s not rocket science in the sense that the fundamental insight
is to watch the developments, what I would call the what, the why and
the when of these crises," White said. "When you’ve seen one of them
and it’s made an impression on you, it’s easier for you to see the problems
building up elsewhere."

That led White to pen admonitions for a series of BIS annual reports.

"Some developments over the past year revealed disturbing laxities
in internal governance, of both corporations and financial institutions,
as well as in oversight and market discipline," White wrote for the
report published in June 2004.

No ‘New Era’

Two years later, he wrote, "The recent historical experiences of
Japan, Germany and Southeast Asia all indicate that costly economic
downturns are possible, even after long periods of exceptional performance."

His darkest warning came on the eve of today’s financial turmoil.

"Virtually no one foresaw the Great Depression of the 1930s, or the
crises which affected Japan and Southeast Asia in the early and late
1990s," he wrote for the June 2007 report. "Each downturn was preceded
by a period of non-inflationary growth exuberant enough to lead many
commentators to suggest that a ‘new era’ had arrived."

ECB President Jean-Claude Trichet praised the BIS as "obviously the
most lucid institution in terms of its own research and publications"
when asked about White after a Feb. 20 speech to the European American
Press Club in Paris.

Social Costs

Beyond the current economic pain, White said the social costs of
a severe economic crisis, in particular potential spikes in extremism,
also propel him in his quest to find a way to limit boom-and-bust cycles.

"When you think about the big economic disruptions, what I always
worry about is that you get into the fault lines on the political and
social side of things pretty fast," White said, citing the confluence
of the Great Depression and Hitler’s rise to power in Germany.

White’s critics often mistake the symptom of asset bubbles for the
cause, which is a rapid increase in credit, he said. While his policy
wouldn’t stop asset appreciation, it might squeeze out some of the gains
that didn’t stem from improved productivity or technology, he said.

Still, he is modest about whether his financial stability elixir
is made up of exactly the right ingredients.

"I’d like to believe that having been right about one thing implies
a greater probability of being right about the other," White said, smiling.
"But, of course, logically it’s not true. It doesn’t necessarily follow."

Too simplistic...

It's been quite a spectacle for those who have followed
Alan Greenspan's career for decades. Gone is the financial rock
star or even the statesman testifying before Congress in a measured
baritone. Instead, over the past several months, Alan Greenspan has
morphed into a totally new person.

The first incarnation was the shaken Greenspan who was stunned that
greedy and reckless short-term behavior could overwhelm long-term, rational
self-interest. That was rather amazing all by itself. But now, there's
a newer Greenspan--a decidedly prickly and whiny one.

I'm talking about Greenspan's recent
op-ed in The Wall Street Journal. A 1,500-word attempt
to move blame for the financial crisis away from himself and onto ...
China.

It was, writes Greenspan, Chinese growth that led to "an excess"
of global savings. That growth kept long-term interest rates low, which
fueled the housing bubble. As for himself, the lowly chairperson of
the Fed, he says he was helpless. He only had control over short-term
rates.

Why this recent incarnation as a self-pitying victim of historical
forces? Most likely, it's because of John Taylor, a mild-mannered professor
at Stanford and former colleague of Greenspan's at the Fed.

In his
Getting Off Track, a nifty little book, Taylor exposes, as
plain as day, the culprit behind the financial boom-bust: Greenspan.
His weapon of choice is the "Taylor rule" (discovered by Taylor--but
not named by him, as he modestly points out.) (The Taylor rule is a
recommendation about how the Fed should set the short
interest rate--suggesting the amount it should be changed given
economic conditions.)

Here's Taylor's take. Short interest rates fell in 2001 in response
to the dot-com bust. But--and here's the important moment--beginning
in 2002, the Taylor rule indicated that Greenspan ought to have tightened.
Indeed, from 2002 to 2005, rates ought to have climbed to a touch over
5% and then stayed there through 2006.

But the Fed kept to a loose monetary stance, and rates kept falling
during the period 2002 through 2004. Rates didn't start back up until
middle of 2004 and didn't reach 5% until 2006. You can check this out
in Figure 1, below.

The result? The Greenspan Loose policy went on to fuel a boom, while
the Taylor Tight would have avoided one. As Taylor says, all the Fed
needed to do was follow "... the kind of policy that had worked well
during the period of economic stability called the Great Moderation,
which began in the early 1980s."

The connection between Greenspan Loose and the housing boom is also
clear. Housing starts took a sharp spike up in 2003 and then continued
to climb through 2006. If the Fed had followed Taylor Tight, however,
housing starts would have peaked at a much lower level at the end of
2003, and drifted down through 2006.

What about Greenspan's argument that he only controlled short-term
rates? And that short rates became decoupled from long-term rates in
2002?

Taylor also takes on Greenspan's excuse that he was helpless in the
face of a global saving glut. Cutting off the feet of Greenspan's excuse,
Taylor says there wasn't a glut, there was a shortage. Figures from
the
International Monetary Fund show global saving rates, as a share
of world GDP, were low during 2002 to 2004--way lower than rates in
the 1970s and 1980s. In fact, the global saving rate fell at the end
of 1990s, hitting bottom about 2003.

Greenspan's monetary excess was also crucial in setting off a chain
of bad government policies. As Taylor argues, Greenspan Loose was amplified
by the popularity of subprime mortgages, especially adjustable-rates,
which promoted risk taking. And it made for a lethal brew in a pot of
policies to promote homeownership.

Greenspan pulls out many stops in his defense. He even quotes the
great Milton Friedman's approving assessment of Fed policy between 1987
and 2005. Well, Friedman died in 2006 and, in 2009, his equally great
colleague, Anna Schwartz, has this to
say: "There never would have been a subprime mortgage crisis if
the Fed had been alert. This is something Alan Greenspan must answer
for." As for Greenspan's argument that the whole mess is China's fault,
she says tartly: "This attempt to exculpate himself is not convincing.
The Fed failed to confront something that was evident. It can't be blamed
on global events."

As fine a last word as there could be.

Susan Lee has written several books on economics, including a
college text. She is an economics commentator for NPR's "Marketplace"
and writes a weekly column for Forbes.

I was wrong, Alan Greenspan said in so many words. Seated before
his congressional inquisitors in October 2008, with the worst financial
crisis since the Great Depression cascading down Wall Street, Mr. Greenspan
confessed that the philosophical principle upon which he had based his
highly influential professional judgment is—flawed.

For some two decades as chairman of the
Federal Reserve,
Greenspan had counseled presidents and Congresses that government deregulation
of financial markets and reliance upon self-regulation by self-interest
was the way of both freedom and prosperity. The collapse of one insolvent
bank after another has called such counsel into question.

Here are Greenspan’s own words: “Those of us who have looked to the
self-interest of lending institutions to protect shareholders’ equity,
myself included, are in a state of shocked disbelief.... The whole intellectual
edifice [of risk-management in derivative markets]...collapsed last
summer.” Asked whether his ideological bias led him to faulty judgments,
he answered: “Yes, I’ve found a flaw. I don’t know how significant or
permanent it is. But I’ve been very distressed by that fact.”

One pillar in the “intellectual edifice” of Mr. Greenspan’s economic
philosophy is the objectivist philosophy of the late Ayn Rand, whose
inner circle Greenspan joined in the 1950s. As explained in her book
The Virtue of Selfishness(1964), Rand believed that the individual
exists solely for her own happiness and thus that rational self-interest
is the only objective basis for moral action. There are no moral constraints
on the selfish pursuit of personal happiness, except force and fraud.
And there is no moral duty to sacrifice individual advantage for any
greater good, because there simply is no greater good than personal
happiness (“egoism”).

In the view of the objectivist philosophy, the only moral economic
system is laissez-faire capitalism, which gives free rein to the selfish
pursuit of individual profit. Accordingly, government should be minimal,
limited to national defense, property protection and criminal prosecution.
In his memoir,
The Age of Turbulence, Greenspan acknowledged Rand as a
“stabilizing force” in his life and reconfirmed as “compelling” the
“philosophy of unfettered market competition.”

Ayn Rand and the Egoist Ethic

As his comments to Congress indicate, Greenspan seemed sincerely
surprised (and distressed) that financial institutions managed by self-interested
individuals seeking to maximize private gain in unregulated markets
would not have more prudently protected shareholder interest from excessive
risk. He had assumed, implicitly, that corporate executives would seek
what was best for the institution and its investors—and hence, that
self-regulated self-interest would align private profit with institutional
good. Given a Randian ethic of rational selfishness, however, one should
be wary of such assumptions.

The egoist ideal is that, short of force
or fraud, I pursue my own advantage regardless of others, because individual
happiness is the ultimate good. Consider executive compensation.
If I am an executive, then on egoist terms, I have limited rational
interest to sacrifice personal gain for shareholder equity on account
of risk assessment, as long as my compensation package guarantees me
multimillions regardless of stock performance. Even if the company crashes,
I escape with my “golden parachute.”

The egoist ethic amplifies this divergence between private interest
and common good throughout the financial market. Consider the mortgage
market. If I am a mortgage lender, then issuing risky loans that are
unlikely to be repaid is a good investment for me, as long as the secondary
mortgage market allows me to pass the risk of default to others—say,
by selling the loans on the secondary market for bundling into mortgage-backed
“securities.” Even if the borrower later goes into default, I have gained
in the market as long as I am able to remove the loan from my books
and reap my commission.

And if I am an investment banker, then purchasing bonds backed by
risky loans is also a good investment, as long as a derivatives market
allows me to “swap” the risk with a leveraged investor or an insurance
company. Even if the underlying loans go into default, I have still
maintained my market position, as long as my credit-default swaps pay
out and I cover my losses.

In short, as long as there is an unregulated market for betting on
loan defaults and as long as there are investors willing to take the
bets, financial risks that promise individual profit with potential
cost to the common good make rational sense. Of course, this game of
risk is sustainable only as long as the bets continue paying off—which
meant in this case, only as long as housing prices continued rising.
With the burst of the bubble in the housing market, resuluting in a
flood of mortgage defaults, bond sellers and default insurers alike
were left unable to make good on their promises, leaving bond holders
to absorb the losses they had gambled others would pay. Although the
risk-takers have reaped their reward in a whirlwind, it is ultimately
stockholders and taxpayers who have borne the real cost through losses
to retirement funds and education budgets.

Greenspan’s “intellectual edifice” of self-regulation by self-interest
has thus collapsed upon its own presuppositions. Having recognized the
“flaw” in his thinking, Greenspan now suggests that financial institutions
selling complex products (e.g., securities backed by high-risk mortgages)
be required to hold a substantial portion of the bonds they issue in
their own portfolio. That is, institutions should be required to expose
themselves to the risk they market to others in order to constrain the
excesses of self-interest.

Reasonable regulation of capital markets and executive compensation
to rein in self-interest, though necessary, does not get to the heart
of the matter, however. The deeper philosophical issue is that the egoist
ethic underlying Greenspan’s theory is an insufficient foundation for
how we envision our economic life. According to the Randian philosophy,
rational selfishness is the chief virtue, its constraint the chief vice.
What the financial crisis teaches us is that excessive self-interest
is economically destructive. Unrestrained
selfishness is thus itself a vice, undermining not only the general
welfare but also self-interest.

While self-interest is the operative principle of the marketplace,
and while Greenspan is correct to argue that markets have made expanding
prosperity possible for many, the unrestrained self-interest that egoism
values has proved corrupting of the very free market in which it was
supposed to flourish. Rational selfishness without moral constraint
has corroded the trust between financial institutions that is necessary
to sustain the flow of credit upon which a market-capitalist economy
depends. Not even the lowering by the Federal Reserve of its lending
rate to practically zero has been sufficient to stimulate financial
markets in the current climate of mistrust.

Buying into the market, inasmuch as it involves risk, depends on
trust; but trust in the market cannot be bought. For trust depends essentially
upon the trustworthiness of prospective buyers and sellers, borrowers
and lenders. Without mutual trustworthiness, freedom of exchange is
undercut, even if the cost of buying into the market (the interest rate,
for example) is cut to zero. Virtue thus is prior to freedom; and without
virtue, freedom destroys itself. The free market cannot operate by self-interest
alone, therefore, but relies on ethical presuppositions.

An Alternate Vision

What is further lacking in the Randian philosophy is a robust concept
of the common good. The common good is more than the competing interests
of selfish individuals (the view on the right). It is also more than
the composite interests of special groups (the view on the left). The
common good is “the good we have in common”—the comprehensive communal
conditions necessary for the virtuous pursuit of human fulfillment by
all in society.

Talk of virtue ethics and the common good is the language of Christian
moral philosophy. The financial crisis, then, issues a special call
to the faithful. American society needs an alternative vision of economic
life to the one that has reigned over the past quarter-century and has
now brought so many institutions and investors to ruin.

The first task of this alternate vision—in the face of ingrained
individualism and endemic egoism—is to reclaim the very fact of our
common life as the basis of our obligations to one another. Times of
crisis remind us of our inter-dependence and summon us to our mutual
responsibilities. Without sustained focus and reflection, however, such
lessons learned can be quickly lost in the public consciousness. (Recall
how soon the official message after 9/11 shifted from “let’s pull together”
to “everyone go shopping.”)

As a Mennonite philosopher, I have found Catholic social teaching
to provide a plentiful resource of reflection on these questions, especially
Leo XIII’s encyclical
Rerum Novarum (1891), where we can find precisely the principle
that we need to re-learn: “Civil society exists for the common good,
and, therefore, is concerned with the interests of all in general, and
with the individual interests in their due place and proportion” (No.
37).

From the perspective of Catholic social teaching, individual interest
is inseparable from the common good. The individual’s claim on the community
is bound up with the community’s claim on the individual. Such mutuality
implies moral principles for the economic system: individual profit
is accountable to the common good; gain for the wealthy is immoral apart
from justice for the poor; economic freedom entails social responsibility
(see the U.S. Catholic bishops’ pastoral letter,
Economic Justice for All, 1986).

Another rich resource for reflection is John Paul II’s centenary
reflection on Pope Leo’s encyclical,
Centesimus Annus (1991), which includes a comment (No.
17) with a remarkable relevance for the current crisis:

We see how [Rerum Novarum] points essentially to the socioeconomic
consequences of an error which has even greater implications....
This error consists in an understanding of human freedom which detaches
it from obedience to the truth, and consequently from the duty to
respect the rights of others. The essence of freedom then becomes
self-love carried to the point of contempt for God and neighbor,
a self-love which leads to an unbridled affirmation of self-interest
and which refuses to be limited by any demand of justice.

The “unbridled affirmation of self-interest”—among buyers and sellers,
borrowers and lenders—was indeed the mantra of the Greenspan era. And
the “socioeconomic consequences” of that “error” are now evident to
all.

Secular Wisdom

The wisdom of virtue ethics and the common good, as Catholic social
teaching itself acknowledges, is not confined to the tradition of the
church. It would thus behoove people of faith, when presenting an alternative
vision to persons of good will in American society who are not Christian,
to seek out sources of such wisdom beyond ecclesial documents.

We could reconsider such classic writers as Aristotle, Aquinas and
Tocqueville. They understood civil society
as the natural setting for human fulfillment, the common good as the
moral horizon of individual pursuit and wise governance to be as important
as individual liberty for the sustainable pursuit of living well.

We would also do well to consider contemporary writers like Robert
Bellah, Stephen Carter and Amitai Etzioni. They not only remind us of
the republican ideal of a common good above private interest, but also
call us away from the egoist ethic of selfish individualism toward a
civic ethic of shared sacrifice and social virtue.

The need now, for both people of faith and all people of good will,
is a return to the ethics of virtue and the philosophy of the common
good, within which human freedom and individual interest find their
“due place and proportion.” The welfare of the nation depends on it.

Newsweek's Michael Hirsh
says that although there are many people responsible for out current
economic meltdown, we should thank one very special guy in particular:

This mess is mostly a titanic failure of regulation. And the largest
share of blame goes back to one man: Alan Greenspan. People mainly
fault the former Fed chief, who once enjoyed a near-saintly reputation
because of his reputed "feel" for market conditions, for ushering
in an era of easy credit that accelerated the mortgage mania. But
the much bigger problem was Greenspan's Ayn Randian passion for
regulatory minimalism. Under the Home Ownership and Equity Protection
Act enacted by Congress in 1994, the Fed was given the authority
to oversee mortgage loans. But Greenspan kept putting off writing
any rules. As late as April 2005, when things were seriously beginning
to go wrong, he was saying that subprime lending would work out
for the common good—without government interference. "Lenders are
now able to quite efficiently judge the risk posed by individual
applicants," he declared at the time. So much for his feel. New
regs didn't get put into place until this past July—long after the
crash had come, under Greenspan's successor, Ben Bernanke. The new
Fed chief's "Regulation Z" finally created some common-sense rules,
such as forbidding loans without sufficient documentation to show
if a person has the ability to repay.

Greenspan has tried to defend
himself repeatedly, though as bank after bank has failed he's retreated
to the shadows. But in a 2007 interview with CBS he admitted: "While
I was aware a lot of these practices were going on, I had no notion
of how significant they had become until very late." This, from
a man who once told me, in an interview, that he most enjoyed scanning
economic reports for hours in his bathtub. Now, with Tuesday's $85
billion bailout of AIG adding to the hundreds of billions the government
has already put up to rescue Bear Stearns, Fannie Mae and Freddie
Mac, this apostle of free-market absolutism has realized his worst
nightmare. He has given us the largest government intervention into
the markets since FDR. Heckuva job, Greenie.

Reimagined as a pitchfork wielding populist reformer (while he tries
to figure out how many houses he owns) John McCain is out on the stump
this week railing about greed and avarice. But it was only yesterday
he was saying this:

"Get ol' Alan Greenspan -- whether he's alive or dead. And um if
he's dead, we'll put dark glasses on him and prop him up like they
did at Weekend at Bernie's."(Town Hall Meeting in Concord, NH 12/17/07)

And then we have Guru number 2, Phil "you're all a bunch 'o whiners"
Gramm, the man McCain extols as an
economic genius:

When Senator Phil Gramm and his wife Wendy danced, it was most often
to Enron's tune.

Mr. Gramm, a Texas Republican, is one of the
top recipients of Enron largess in the Senate. And he is a demon
for deregulation. In December 2000 Mr. Gramm was one of the ringleaders
who engineered the stealthlike approval of a bill that exempted
energy commodity trading from government regulation and public disclosure.
It was a gift tied with a bright ribbon for Enron.

Wendy Gramm has been influential in her own right. She, too,
is a demon for deregulation. She headed the presidential Task Force
on Regulatory Relief in the Reagan administration. And she was chairwoman
of the U.S. Commodity Futures Trading Commission from 1988 until
1993.

In her final days with the commission she helped push through
a ruling that exempted many energy futures contracts from regulation,
a move that had been sought by Enron. Five weeks later, after resigning
from the commission, Wendy Gramm was appointed to Enron's board
of directors.

According to a report by Public Citizen, a watchdog group in
Washington, ''Enron paid her between $915,000 and $1.85 million
in salary, attendance fees, stock options and dividends from 1993
to 2001.''

As a board member, Ms. Gramm has served on Enron's audit committee,
but her eyesight wasn't any better than that of the folks at Arthur
Andersen. The one thing Enron did not pay big bucks for was vigilance.

There's a lot more you can say about the Gramms and Enron, and
not much of it good. But Phil and Wendy Gramm are just convenient
symptoms of the problem that has contributed so mightily to the
Enron debacle and other major scandals of our time, from the savings
and loan disaster to the Firestone tires fiasco. That problem is
the obsession with deregulation that has had such a hold on the
Republican Party and corporate America.

Enron is so 2001, right? Something out of the past. Except it really
isn't. It's yet another example of the GOP's deregulation fetish of
the past quarter century, which seems to result every, single time in
a bunch of people losing their savings and the taxpayers being on the
hook for billions. Sure, the big boys have to take some heat --- why
some of them are down to their last 100 million or so. But seeing as
they've been swallowing a fire hose of money for the past seven years,
I think they'll pull pull through. The rest of us have to stay up nights
wondering what the hell the next few years are going to bring us.

And John McCain has been out there selling this crap the whole time,
vacationing with Keating, being best buds with Gramm and drooling over
Alan Greenspan like a Hannah Montana fanboy. If anyone expects change
from this guy they are living in a total dreamworld. He's one of them.

If you like useless expensive wars, financial scandals, stock market
crashes, foreclosures and economic instability as far as the eye can
see, vote Republican. They've got everything you need.

Alan Greenspan’s March 11 opinion piece in the Wall Street Journal
(“The Fed Didn’t Cause the Housing Bubble”) sought to cast doubt on
growing suspicions that the Fed shares substantial blame for the current
global crisis. We find Mr. Greenspan’s denials and assertions unreasonable.
Let there be no doubt; the Fed is largely responsible for the current
economic crisis and, as the Chairman of the Fed leading up to the crisis,
Mr. Greenspan was one of its principal architects.

Mr. Greenspan cited two generally accepted “broad and competing explanations
for the origins of the crisis” that he then cast as spurious: 1) easy
monetary policies, which he summarily dismissed as in-credible and 2)
the “far more credible” (and later denied) notion that interest rates
stayed low despite Fed rate hikes, which “spawned speculative euphoria”.
Mr. Greenspan seemed to try to separate the Fed from blame by asserting
the Fed “lost control” of mortgage and longer term rates because of
an organically-created “excess savings pool.”

We find the construct for Mr. Greenspan’s plea lacking. As the body
responsible for targeting overnight funding rates in a largely finance-based
economy, the Fed is (or should be) concerned only with the interest
rate or quantity level of overnight funds relative to available returns
that investors may capture from borrowing those funds. The absolute
levels of the Fed’s target rate or market-based interest rates do not
matter.

Consider that the shadow banking system
comprised of global leveraged arbitrage investors (on Wall Street and
independent of Wall Street) care only about yield spreads, not about
yields. A Fed funds target that rises from 1% to 5.25%
over two years may not induce a diminution of credit issuance because
as long as arbitrageurs may buy credit paper
with higher yields than their funding costs, they will continue do so.

Against this more relevant backdrop,
Mr. Greenspan’s Fed maintained an extraordinarily easy monetary policy
throughout his tenure, even at times when overnight funding rates rose.
This easy money policy engendered credit expansion; at first among mostly
creditworthy borrowers, then among more marginal borrowers and ultimately
among dubious borrowers with virtually no hope of repaying their home
mortgage and consumer loans.

Nevertheless, we will respectfully address Mr. Greenspan’s arguments
and then seek to substantiate our claim that the Fed is indeed largely
responsible for the current crisis.

* * * * *

Regarding low interest rates, Mr. Greenspan argued that from 2002
to 2005 mortgage rates decoupled from their long history of being tightly
correlated to short-term benchmark interest rates that the Fed controlled
and/or heavily influenced. He noted that the leading indicator of home
prices was the mortgage rate and not the fed-funds rate, which the Fed
explicitly targets. Any fact-checker can see this is true, but it is
an irrelevant data point taken out of context. As we have already implied,
the driver of home prices from 2002 to 2005 was easy credit that ultimately
influenced mortgage rates lower than pure economic fundamentals would
have dictated.

Indeed, the record is clear that the Fed chose an easy money path
that created supplemental demand in US
Treasury and mortgage markets. This artificially-induced demand in turn
caused mortgage rates to drop to
artificially low levels (i.e., levels not explicitly tied to true home
values or borrower credit risk), and to then be relatively insensitive
to rising funding rates later on.

A little background is appropriate. The mechanism the Fed deploys
to create credit is time-worn and well known among Wall Street bankers.
Simply, the Fed provides daily amounts of credit to Wall Street primary
dealers through repurchase agreements. (Fed repurchase agreements or
“repos” are overnight or short-term credit facilities between the Fed
and the largest Wall Street banks in which eligible collateral is swapped
in return for Fed credit in the form of US dollars. The borrowers pay
an implicit interest rate — or repo rate — for this credit that finances
their balance sheets.)

There was (and remains) no limit to the repo lines the Fed and Wall
Street may create (other than the amount of eligible assets that may
be offered as collateral), meaning the Fed largely controls the amount
of US dollar-based credit provided to the markets. In short, through
the repo market the Fed controls/supplies funding for the largest Wall
Street banks and, secondarily, the shadow banking system (the securitization
process and levered buyers of those securities that borrow from Wall
Street).

Through Fed repos, Wall Street was able to grow its collective balance
sheet dramatically and then use it to
distribute — through the shadow banking system — credit to homeowners
and consumers. Wall Street provided vendor financing to leveraged debt
investors through their profitable prime brokerage units. Yet, ultimately,
the credit came from the Fed. (The Fed and commercial banks “create,
distribute and sometimes even extinguish” credit while Wall Street “intermediates
and demands” it. Wall Street does not create it but does “market” and
“redistributes” it.)

Ironically, Mr. Greenspan seems to be pointing his finger at banks
and borrowers for taking the Fed’s credit. (Even more ironic is that,
as the Fed Chairman, he was the chief bank regulator and could have
stepped in to prevent bank, and ergo, leveraged-investor balance sheet
growth by demanding and enforcing more traditionally- stringent lending
standards.)

We assert that Mr. Greenspan knew perfectly well what he was doing
and, as the graph below indicates, he was quite proficient in meeting
his goals. Beginning in 1996, the Fed seemed to have increased the magnitude
of its repo program dramatically as indicated by the expanding differential
of M3 growth (green line), which includes repurchase agreements, and
M2 growth (blue line), a narrower money stock measure, which does not.

M2, M3
Source: St. Louis Fed

We can see from the graph the degree to which the Fed financed Wall
Street directly and thus, the shadow banking system, indirectly. Notable
is that from 1981 to 1996, the growth rates of M2 and M3 tracked one
another quite closely, implying the Fed’s manufacturing of credit would
be sustainable (a dollar loaned could be paid back with an existing
dollar). However, from 1996 to 2006 — during Mr. Greenspan’s chairmanship
— M3 growth consistently pulled away from M2, implying increasing future
hardship for debtors with obligations to repay the credit leant to them.
The red line at the bottom of the graph represents the difference in
growth rates of M2 and M3.

(Curiously, the Fed ceased publishing M3 in March 2006 to save on
“administrative costs.” Hmm. Who could blame it? The growth of M3 relative
to M2 seems to provide clear evidence of risk-enticing Fed monetary
policy.)

From 1996 to 2006, M3 grew from about $4.7 trillion to about $9.6
trillion, an astounding average annual increase of 10.2%. M2, the narrower
monetary aggregate that does not include repurchase agreements, rose
a more modest 8.2%. This difference was a big deal. In these ten years,
M3 growth compounded to a 94% increase over M2 growth. This difference
reflects the aggressiveness of Fed-lending to Wall Street, ergo the
capital markets, ergo the housing and derivative markets.

We assert that without this Fed-induced financing, the credit, housing
and derivative bubbles would not have developed to anywhere near the
magnitude they ultimately did. The nexus of these bubbles was a currency
bubble initiated and exacerbated by the Greenspan Fed. It appears the
Maestro sacrificed the future for the present, which is a sure way to
make people on Wall Street, Main Street and in Washington happy…temporarily.

We must ask ourselves why banks and investors would keep buying homeowner
and consumer debt even as
interest rates began rising in 2004. The answer is simple: as long as
banks could maintain a profitable spread between the rate at which they
borrowed overnight from the Fed (the repo rate) and either the rate
at which they could lend directly or the rate of return implicit in
the fees they generated by effectively re-structuring and distributing
their repurchase agreements (and, as long as debt buyers could maintain
a positive arbitrage), then the actual level of interest rates – benchmark,
mortgage or consumer rates – didn’t matter. It was, as all things financial
usually are, the “spread” that mattered.

Wall Street and the shadow banking system were fundamentally engaged
in a grand carry trade for which the Fed provided funding. This is the
business of finance, which is precisely the business that Wall Street
and investors practice. After fourteen years at the helm of the Fed
(in 2002) Mr. Greenspan should have known this (or, might we dare say,
should not have forgotten this).

* * * * *

By 2007 the entire interest rate pricing structure had been corrupted
by: a) the difference in the amounts of credit previously sold and the
available funds necessary to retire that credit and, b) generally-accepted
benchmarks that erroneously signaled all was well when all was anything-but-well.
There seems to have been a bit of deception that made the markets seem
healthy when in reality they were not.

To start, we think low inflation expectations subsequent to a time
of very high monetary inflation (1996 to 2006) may have made it an inevitability
that the bubble would burst. Treasury Inflation-Protected Securities
(TIPS) are viewed upon by the fixed-income markets to be a practical,
market-based indicator of inflation expectations. While their yields
may have accurately reflected — and still reflect — the public’s general
perception of low future inflation rates (at least as expressed by CPI-U),
they did not in 2007 — and still do not – compensate investors for anything
close to recent historical or anticipated monetary inflation rates in
our view.

Without getting into too much detail, it is broadly agreed that in
pure economic terms inflation is a monetary phenomenon in which changes
in the stock of money (and by extension, credit) determine changes in
nominal prices for goods, services and assets. Simply, the more dollars
outstanding, the less purchasing power each has and the more dollars
it takes to purchase an item. In other words, money creation produces
nominal price increases and money destruction (a dynamic that has not
occurred for any length of time since the Fed was established in 1913)
would produce price declines.
This has real-world investment applications. As is evident in the graph,
the substantial and consistent creation of asset-supporting credit by
the Fed from 1996 to 2006 also created the future need for more dollars
to service and pay down that credit. So inflation was (and is) built
into the system yet few investors seemed positioned for it. Either the
value of credit had to drop or the amount of money in the system had
to rise to repay that credit. (This is literally the same dynamic that
perpetuates a Ponzi scheme – the need to find or manufacture more money
to satisfy existing claims.)

But there is a far more granular reason for the bursting of the currency/credit
bubble. Too much credit in the system drove down fixed-income yields
across the board (thanks to a wide arbitrage spread separating funding
rates from nominal debt yields). When the Fed began allowing the fed
funds rate to rise in 2004, it triggered a narrowing arbitrage spread
and nominal price losses on the bond side of the arbitrage. This, in
turn, triggered redemptions for bond funds like the Bear Stearns mortgage
funds.

There was an air pocket underneath. Bonds and their derivatives were
being priced at the margin by leveraged arbitrageurs. Smart real money
buyers were waiting for positive real yields which, given the aggressive
monetary inflation at that time, could only be found at nominal yield
levels well in excess of those then available (hey, today’s “safe haven”
Treasury buyers, are you listening?). Can Greenspan’s Fed be held accountable
for this?

We think so. In 2004 the Fed began to allow a progressively higher
fed funds rate to “be targeted” which created the perception of tightening
monetary policy. Yet the Fed was NOT TIGHTENING AT ALL. Despite a steadily
rising fed funds rate we believe the Fed stood by as market-based funding
demand continued to increase substantially. In fact, short-term credit
provisions from the Fed continued to grow during this time. Indeed the
Fed pursued an easy money policy despite the optics of it “targeting”
a higher funds rate. To us, “easy money” means more money and credit,
not less.

Orthodox economic supply/demand curve analysis has no difficulty
reconciling a progressively higher fed funds rate with simultaneous
growth in the quantity of credit clearing in the marketplace. (Don’t
demand curves shifting to the right create both higher clearing prices
and clearing quantities? And, don’t supply curves shifting to the left
create higher clearing prices but lower clearing quantities? We intuit
a lot of the former and little to none of the latter during the period
in question.)

We argue that Mr. Greenspan would have had to restrict Fed credit
far more than he did if he wanted to close the arbitrage spread giving
bond investors incentive to keep adding credit to their balance sheets.
He should have shifted the funds rate higher and more forcefully. The
move in the fed funds rate from 1% to 5.25% from 2004 to 2006 was woefully
inadequate and should have been MUCH more aggressive if spurious credit
demand were to be discouraged. Put slightly differently, we assert that
the ENTIRE fed funds move from 1% to 5.25% was driven by increased credit
DEMAND (levered credit buyers had incentive to put as much on their
balance sheets at a positive spread between funding costs and bond yields).
Mr. Greenspan didn’t seem to get this.

Had the Fed wanted to restrict the clearing quantity of credit, it
would have had to target a fed funds rate well in excess of 5.25% and/or
acted much quicker than it did. The Fed would have needed to restrict
SUPPLY and thus target less growth in overall credit. This, no doubt,
would have endeared him to no one (but former Chairman Volcker perhaps?).

More forceful credit restriction would have clearly retarded any
growth in demand from the shadow banking
system and the credit bubble would have been stopped in its tracks well
before it burst. We don’t believe that Econ-101 supply/demand curve
analysis is beyond Mr. Greenspan’s reach as he seems to protest, nor
was it so when he was Chairman of the Fed.

* * * * *

In a broader sense, real (inflation-adjusted) losses had already
been locked-in by fixed-income investors because prevailing absolute
nominal yields were lower than the higher rate of monetary inflation.
And as we discussed, the Fed’s monetary inflation between 1996 and 2006
actually produced lower absolute bond yields than would have otherwise
prevailed (too much money chasing bonds). Why did this “irrational investment
behavior” occur?

It was not irrational-investor behavior though it was irrational
investing. We think there were two inter-related issues at hand: 1)
investors didn’t mind running a mismatched asset/liability book because
they were compensated at shorter intervals and, 2) conventional economic
wisdom, that seems to have been fostered and encouraged by policymakers,
produces terribly inaccurate economic data that these mismatched investors
used to justify their actions. (The two dynamics remain in place today.)

For example, the Consumer Price Index (CPI) and other price baskets
generally used as “inflation” indicators had not risen to reflect gross
monetary inflation produced by the Fed from 1996 to 2006. This is not
proof that money growth does not equal inflation; rather it is proof
that the CPI does not accurately reflect the diminution of a dollar’s
purchasing power. (If an indicator like the M3 growth rate had been
a generally-accepted inflation metric — not perfect but closer than
highly subjective price baskets — then there would not have been buyers
of credit at negative real yields.)

In this light, it would also not appear to be acceptable Fed regulatory
policy to assume that Wall Street banks — competitive publicly traded
institutions with quarterly incentives to produce ever-increasing revenues
— would somehow not re-distribute that credit to its credit-purchasing
clients (that they were vendor-financing). It is also not reasonable
to assume that credit buyers — competitive institutional asset managers
with daily incentives to produce competitive returns relative to benchmark
indexes and their peers, not relative to the creditworthiness of the
instruments they were buying or even the real returns they were producing
— would somehow not buy that credit priced at yield spreads above diminutive
benchmark Treasury yields and funding rates (particularly when many
of those asset buyers accessed leverage through Wall Street banks.).

There is more to Mr. Greenspan’s assertions that we find troubling.
As he brought up for the second time in as many years:

“As I noted on this page in December 2007, the presumptive cause
of the world-wide decline in long-term rates was the tectonic shift
in the early 1990s by much of the developing world from heavy emphasis
on central planning to increasingly dynamic, export-led market competition.
The result was a surge in growth in China and a large number of
other emerging market economies that led to an excess of global
intended savings relative to intended capital investment. That ex
ante excess of savings propelled global long-term interest rates
progressively lower between early 2000 and 2005.”

Mr. Greenspan surely knows that there cannot be “an excess pool of
savings” because, by definition, the pool of savings equals the pool
of investment. (Mr. Bernanke seems guilty of this lapse too, we’re afraid.)
However, there is an excess pool of “currency” in today’s world. Again,
as the simple laws of supply and demand suggest, an increase in the
supply of currency which is not coincident with an increased supply
of assets will drive asset prices higher. A prudent central banker acting
in the interests of economic stability would have absorbed that excess
pool of currency (and would not now dub it as “savings”).

In an honest or “hard” money system, the “tectonic shift” Mr. Greenspan
discusses would have led to CPI
deflation as the newly accessible pool of cheap Asian labor would have
been deployed in the productive process. This would have implied lower
consumer prices and higher interest rates. There would have been better
margins helping asset prices on the one hand, and higher interest rates
hurting them on the other. The net effect on productive asset prices
would thus be ambiguous.

But the economy would have been sustainable and the US dollar would
have remained sound. Clearly, Mr.
Greenspan allowed the various measures of the monetary aggregates to
inflate and his reputation did not suffer for it during his tenure.
The organic forces of price deflation provided him a shield. Why
did he do this? To keep asset prices up? To keep US tax receipts up?
The effect of his actions hurt dollar-based savers, fixed-wage workers
and people living on a fixed-income. All would have been better off
if the purchasing power of the dollar were to have been maintained or
even, via the “tectonic shift”, enhanced.

And finally, Mr. Greenspan’s reminder that “prior to the crisis,
the U.S. economy exhibited an impressive degree of productivity advance”
is almost too much to bear. If this were true, where then were the fruits
of this productivity advance? Doesn’t an increase in productivity, ceteris
paribus, imply lower output prices and thus lower consumer prices? (Is
this the “shabby secret” of modern central banks — they are inflation
machines that counterbalance natural deflationary pricing forces brought
about by private sector competition?) Mr. Greenspan’s record is crystal
clear and his knack for obfuscation is not as charming now — or helpful
to society — as it appeared it once was.

4 Responses to “The Maestro Has No Clothes”

If, coming out of a tech bubble and mild recession, an increase
from 1% to 5.25% was woefully inadequate, what size increase will
be necessary to take away the punch bowl this time? I just don’t
see the Fed having the cojones to do it (maybe that’s why Obama
has Volcker waiting in the wings).

Maybe the economy was okay to soak up all this money.
1) Population increase Immigration and job creation
2) If people understood inflation and excepted price increases
3) Job and wages followed inflation / population increase.
4) Investment class sold real estate near peak. denial of inflation.
5) Investment clases compensation and wages were controlled rationally
and re-invested into sound business activity instead of more paper
investments.

Just playing devil’s advocate here. Yes it would be easier to
regulate the money than all things here.

The Bush tax cuts in ‘03 came at a time of relatively full employment,
so they had no or little real output effect but almost exclusively
an inflationary one. Greenspan accomodated the fiscal stimulus by
expanding M2/M3 as you have noted, keeping interest rates low and
adding fuel to the inflationary fire. Rather than seeing a widespread
increase in prices, however, the inflationary effects were directed
to a broad-based market in which the speculative profit from price
increases was largest and the opportunities least regulated (by
Greenspan among others), the mortgage origination/securitization
market and thus to housing. Ergo, the bubble.

Since Greespan’s low interest rates meant that private real investment
was not being crowded-out, the real resources for the financing
for the huge deficit spending from those tax cuts, Medicare expansion,
2 wars, and an unprecedented expansion in other defense-spending
had to come from somewhere. China obliged.

Thus Greenspan and now Bernanke have it backward: There was no
saving glut from China but a huge desire for dissaving in the US
from the tax cuts. Effectively, Bush spawned a housing bubble, Greesnspan
ratified it, and the real resources needed for this excess came
from China, Japan, Germany, etc. , who became double winners at
our expense: the increasing capital surplus account for the US spawned
an increasing current account deficit to drive their export-oriented
economies. We threw a party–guns are good, houses are better, and
paying for them with taxes (Bush) or interest rates (Greenspan)
or reduced private investment (both) is bad–and paid for it by posting
a big sign saying “For sale America.”

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